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Serving Sri Lanka

This web log is a news and views blog. The primary aim is to provide an avenue for the expression and collection of ideas on sustainable, fair, and just, grassroot level development. Some of the topics that the blog will specifically address are: poverty reduction, rural development, educational issues, social empowerment, post-Tsunami relief and reconstruction, livelihood development, environmental conservation and bio-diversity. 

Monday, May 02, 2005

Growth dives to 5.4% in ‘04 on internal, external shocks

Central Bank points to economy’s resilience but says a high 6-8% growth needed to reduce poverty, more jobs; lists downside risks for 2005

Daily Mirror: Financial Times: "30/04/2005

The economic growth in 2004 dipped to 5.4% last year from 6.6% in 2003 due to internal and external shocks and Central Bank yesterday urged for higher rates of 6-8% if the country were to reduce poverty and generate jobs to desired levels.

"The growth of over 5% is a reflection of the economy's resilience to the many adverse shocks the country had to face during the year - the surge in international oil prices, a severe drought in the early part and the floods later on in the year and finally, the tsunami disaster," Central Bank said in its 2004 Annual Report released yesterday.

"The growth was largely supported by the strong performance in exports, consumption and investment and the resurgence of economic activities benefiting from the continuation of the ceasefire," it said.

Despite lower GDP growth a noteworthy achievement in 2004 was that the country's per capita GDP exceeded US dollars 1,000 for the first time. "With this achievement, it is expected that Sri Lanka would make further progress towards becoming an upper middle income country," the Bank said. Another development was investment to GDP ratio improving to 25% from 22.1% in 2003. This was entirely due to increased private investment. However Central Bank said that this figure should rise to atleast 30% in the near future as a platform for higher GDP growth.

Domestic savings and national savings remained unchanged at 15.9% of GDP and 21.6% of GDP, respectively, in 2004. This led to a widening of the savings-investment gap, which was financed through the increased utilisation of foreign savings and official reserves, as reflected by the widened current account deficit in the balance of payments (BOP).

"As these levels of savings and investment are not adequate to raise growth and the standards of living substantially, a concerted effort must be made to raise savings and investment," the Bank said adding that higher investment needs to be channelled to improve essential infrastructure, which would be most productive in promoting a higher and regionally balanced growth. Western Province accounted for 49% of the GDP.

Healthy developments in the Services and Industry sectors contributed to economic growth in 2004 although the Agriculture sector faced a setback due to adverse weather conditions. The Services sector, which grew by 7.6% in 2004, as reflected by the growth of wholesale and retail trade, hotels and restaurants, transport and communication, and financial, real estate and business services sub-sectors, contributed 77% to the overall growth. Strong external and domestic demand helped the Industry sector to grow by 5.2%, contributing 25.7% to the overall growth. The Agriculture sector recorded a negative growth of 0.7% in 2004.
Looking ahead, sustainable growth in agriculture requires increased contributions from both plantation and non-plantation sectors. The plantation sector needs further improvements in productivity and to move towards crop diversification. In the non-plantation small-holder sector, while productivity improvements need to be further continued, access to finance and land utilisation issues also have to be addressed. Furthermore, guidance should be provided to farmers through sustainable extension services, for better water and input management and improved new crop varieties. The key to raising agricultural productivity lies in the introduction of high yielding varieties, the use of new technology such as drip irrigation and poly tunnels, the adoption of research and technological developments, the use of advanced crop practices through international partnerships and the more efficient use of inputs. Developments in irrigation infrastructure should be accelerated to support the Agriculture sector, the Bank said whilst welcoming the recent resurgence in developing and rehabilitating tanks and waterways. The Bank also called for reduction of harvest losses in agriculture which is estimated to be around 30-35% of production.

Inflation, which was low throughout 2003, began to rise in 2004 with the drought and the higher fuel prices leading to high cost-push inflation, while the increase in money supply and fiscal expansion, led to demand-pull inflation.

Monetary policy during 2004 aimed at containing inflationary pressures, while supporting economic growth. However, monetary management became more challenging in 2004 with rising inflation and increasing domestic credit demand. The Central Bank conducted its monetary policy in an independently floating exchange rate regime within a framework of targeting monetary aggregates.

The monetary policy was implemented through active open market operations, which includes, as its main component, the interest rate corridor formed by the Repurchase (Repo) rate and the Reverse Repurchase (Reverse Repo) rate and permitting the market to determine the interest rates within this corridor. This effort was supplemented by maintaining the Statutory Reserve Ratio (SRR) unchanged at 10%. In the context of continuous sales of foreign exchange by the Central Bank to dampen excessive exchange rate volatility, the Central Bank injected funds through the purchase of Treasury bills in the primary market, to prevent a liquidity shortage in the money market and any undue fluctuations in interest rates.

The difficult economic conditions that prevailed in 2004 required proper timing and sequencing of monetary policy tightening. With further acceleration of inflation and monetary growth by mid-2004, as the first step, the Central Bank began to conduct open market operations aggressively from June 2004 and absorbed almost the entirety of the liquidity surplus, inducing an upward adjustment in the short-term cost of funds, so as to contain the growth in monetary aggregates. Second, the Bank's Repo and Reverse Repo rates were raised by 50 basis points in November 2004. Meanwhile, to contain non-essential consumption such as the importation of motor vehicles, a 100% margin deposit requirement was enforced on letters of credit opened for the importation of motor vehicles for private use. The Central Bank expects to contain monetary expansion at 15% in 2005 to rein in inflationary pressures in the economy.

On the external front, both trade and current accounts in the BOP recorded deficits. A high import growth of 20%, largely due to high international fuel prices, surpassed the 12% growth in exports and the 11% increase in worker remittances. The surpluses in the capital and financial accounts were not adequate to cover the current account deficit due to lower than expected programme loans from the World Bank and the Asian Development Bank (ADB). Hence, the overall BOP registered a deficit of US dollars 205 million and the effective exchange rate (based on the 24 currency basket) depreciated by 11% and 1.1%, in nominal and real terms, respectively.

International oil prices increased sharply in 2004, raising Sri Lanka's average import price of crude oil to US dollars 37 per barrel from US dollars 29 per barrel in 2003, resulting an increase in the oil bill by US dollars 372 million. This contributed to the worsening of the BOP and the fiscal situation with a substantial increase in subsidy payments to oil distributors, and the continuation of inefficient use of fuel since domestic prices have not been fully adjusted to reflect increases in international prices. The increased subsidy expenditure could have been utilised for raising the level of investment substantially, for instance, meeting the entire cost of a large investment project such as the Southern Expressway.

The conduct of fiscal policy in 2004 was a challenge in the face of internal and external shocks that were threatening to slow down the economy. The government's overall fiscal deficit increased to 8.2% of GDP compared with 8.0% in 2003. The concomitant public sector deficit, which is the total of government deficit and the operational losses of public sector corporations, was 8.4% of GDP in 2004, compared with 7.8% in 2003, mainly due to the operational losses of the Ceylon Petroleum Corporation (CPC) and the Ceylon Electricity Board (CEB). In this context, the government revised fuel prices upwards in 2004. Nevertheless, the revisions were not adequate and the spillover effects of increases in international prices continued to be a heavy burden on the public sector. The increased public sector deficit in 2004 was financed largely through borrowings from domestic sources due to a shortfall in foreign financing. However, government debt and public sector debt as percentages of GDP decreased marginally to 105.5% and 107.5%, respectively, in 2004 from 105.8% and 107.9%, respectively, in 2003, due to a higher increase in nominal GDP compared to the increase in debt stocks in 2004.

The government that took office after the general election in April, set new directions to the growth and poverty alleviation programmes with a greater focus on a regionally balanced growth as well as rural and small and medium sector development.

The fiscal consolidation process continued in 2004 with the government introducing a series of measures to improve the revenue performance and rationalise expenditure. These included the strengthening of the tax administration, the introduction of the Economic Service Charge (ESC), the revision of administered prices, the rationalisation of recurrent expenditure, the strengthening of public enterprises by setting up the Strategic Enterprises Management Agency (SEMA), and the establishment of the Administrative Reforms Committee (ARC) and the National Council for Administration (NCA). In addition, transparency in government procurement was strengthened by adhering to the reporting requirements of the Fiscal Management (Responsibility) Act (FMRA) and setting up of the National Procurement Agency (NPA).

The government's policy statement and the medium term macroeconomic framework announced with the Budget 2005 set out broad strategies to achieve macroeconomic stability and a regionally balanced economic growth rate of 6-8% over the medium-term. The policy envisaged prominent roles for both the public and private sectors, and pro-poor, pro-growth strategies, while continuing market based economic policies pursued by successive governments over the past two and a half decades.

The medium term macroeconomic framework presented with the Budget 2005 has been revised by taking into account the impact of relief, rehabilitation and reconstruction associated with the tsunami disaster. Economic growth would suffer in 2005 albeit marginally, mainly due to the impact on the fisheries and tourism sectors. Increased rebuilding activities would compensate to some extent for the loss of economic activities in fisheries and tourism. The growth is expected to accelerate to over 6% from 2006 onwards spreading across all sectors and geographic regions with the renewed emphasis on regional development as well as the nation rebuilding programme by the government.

Several downside risks remain in achieving the immediate as well as the medium term targets. First, the risk of a further escalation of international oil prices still remains. Any further increase in oil prices could exert a heavy burden on the economy and the people. Second, the global economy has already shown signs of a slowing down in 2005. This may threaten Sri Lanka's export performance. Third, Sri Lanka's major export industry, the textile and garments, is faced with increased competition in the world market due to the phasing out of the Multi Fibre Arrangement (MFA) in 2005. Fourth, any delay in the disbursement of pledged foreign assistance may delay the urgent rehabilitation and reconstruction work, affecting the overall economic performance and the realisation of the expected fiscal consolidation in the medium term. Thus, the country needs to be prepared to face any of these adversities.

The Bank's Annual Report contains a detailed analysis of Sri Lanka's economic performance in 2004 and the medium term prospects, highlights economic issues and policies, outlines the activities of the Central Bank and also contains major financial legislation.

As required under Section 35 of the Monetary Law Act, the Monetary Board of the Central Bank submitted its fifty fifth Annual Report, in respect of the year 2004, to Finance Minister Dr. Sarath Amunugama yesterday.

Other articles on the Central Bank's Annual Report for 2004
Daily News: "30/04/2005 High growth reflects economic resilience
The Island: "30/04/2005 Sri Lanka economy resilient, GDP grows 5.4% despite adverse impacts in 2004

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