The economy is expected to grow by around 4.5% this year, compared with a 6% growth last year, the Central Bank’s Annual Report for 2000 released on Monday said. Annual average inflation rate is projected to increase from 6.2% in 2000, to about 9.5% in 2001.

The net effect of the projected slowdown in world economic growth and the enhanced market access for Sri Lankan garment exports to EU countries following the recent removal of quota restrictions, indicate a moderate growth potential in the Sri Lankan export manufacturing sector in 2001.

Central Bank’s Director Economic Research Dr A.G. Karunasena, addresing a press conference held in connection with the release of this Report said that the additional income that is expected to be derived this year as a result of the EU countries removing their quota restrictions was in the region of US$ 200 million.

The report further said that new credit requirements of public corporations are expected to be low in 2001. "In fact, some of them may even be able to repay a part of their existing bank loans due to improvements in cash flows following increases in administered prices."

Karunasena said that the price adjustments (increases) made by government institutions such as the Ceylon Petroleum Corporation on diesel and kerosene, would assist such institutions to pay at least a part of their debt.

The report also said that monetary management will be a challenging task this year under the new exchange rate system introduced in January 2001. Monetary policy has to remain tight during the initial part of 2001, until the fiscal adjustments take effect and reserves start to increase.

Karunasena mentioned that one of the positive features in this direction was the Government’s commitment in this year’s budget to freeze salary increases in 2001 and the announcement of the closure of a number of unprofitable state run institutions.

Meanwhile, the report said that the reason for a predicted lower growth this year (as compared with a 6% growth last year), was due to a slower growth rate in agriculture due to adverse weather conditions, the moderation of the manufacturing sector growth rate after achieving a higher capacity output in 2000 and an associated reduction in the growth rates in trade and other services

Tea production is projected to continue its growth momentum in 2001, while rubber production is expected to recover from the decline in 2000. However, the effect of adverse weather on 2000/2001 Maha paddy cultivation and the projected decline in coconut production from its peak in 2000, will moderate overall agriculture growth in 2001.

Growth is expected to continue at a high level in the telecommunications, power and construction sectors, while a recovery is projected in tourism. Inflation is expected to be higher in 2001 due to cost push factors such as increased import prices and full pass-through of increases in administered prices in 2000.

It is likely to rise and remain at a high level during the early months of the year. However, prices are expected to stabilise in the latter part of 2001. A significant turnaround is expected in the balance of payments, with a lower current account deficit of US$ 463 million and an overall surplus of US$ 140 million.

A continuation of the growth momentum in exports, though at a slower pace than the high rate in 2000, lower international prices for petroleum products, reduced expenditure on defence imports, continued increase in private transfer inflows, net foreign inflows through portfolio investments, an expected increase in foreign direct investment, improvement in utilisation of foreign assistance by the Government, expected Government medium-term foreign borrowing of US$ 200 million and a projected inflow of US$ 275 million on account of privatisation proceeds, underpin the achievement of this surplus, the report said.

The current account deficit is expected to decline from 6.4% of GDP in 2000 to 2.9% in 2001, reducing external sector imbalances significantly. Total international reserves, as well as the official international reserves are expected to improve in 2001, raising the country’s import capacity.

The expected fiscal improvements and a reduction in credit demand by public corporations will permit the accommodation of higher credit expansion to the private sector (by about 10%) in 2001, without exerting pressure on interest rates and contributing to inflation.

The expected improvement in the net foreign assets of the Central Bank will enhance market liquidity, while enabling the Bank to reduce a part of its holdings on government paper, which increased significantly in 2000.

This is necessary to prevent cost-push inflation resulting from administered price increases and exchange rate depreciation turning into a demand fuelled inflation, the Report said.

Subsequently, with improved rupee liquidity in the market, reduced public sector borrowing requirements, improved stability in the financial market and reduced inflationary pressure in the economy, the Central Bank would be able to reduce its interest rates (repurchase and reverse repurchase rates) gradually over the year, without creating the risks of demand fuelled inflationary pressure.

However, the realisation of the fiscal targets envisaged in the 2001 Budget and expected improvements in the financial position of public corporations are necessary conditions to ensure the achievement of these monetary targets and the expected reduction in interest rates in 2001, it added.

Any significant deviation in achieving the planned public sector borrowing reductions would not only make it difficult to reach these desirable monetary targets and reduction in interest rates, but could also exert pressure on the exchange rate. Thus, under the new exchange rate system, fiscal policy has an important role to play in achieving macroeconomic stability, the report further said. (PA)