Part one of the address delivered by Professor A D V de S Indraratna to the Colombo Rotary Club on 17 April, 2008

Introductory Background

Six decades ago, Sri Lanka gained political freedom from the British Raj with the destiny of her economy vested in her. But she has, not been able to take off into high sustained economic growth so as to eradicate poverty and unemployment among her people. At present, more than 15 percent of her population remains absolutely poor and malnourished, and the country is lagging behind many Asian countries. who were far behind her economically when she gained Independence. What went wrong? The shortest answer is that she did not utilise the economic opportunities, overcoming the political challenges, which befell her. What then is the future outlook? This ties up with the present economy.

Despite the devastation caused by tsunami in December 2004, and the subsequent adverse shocks such as the oil price hike and the rise in international commodity prices, particularly of foods, and the worsening security situation, the economy has been resilient and has been able to record more than 6 % growth consecutively in each of the last three years. This is in itself a record, even though it has fallen short of the targets originally set out in the Ten Year Development Framework under Mahinda Chintana : Vision for a New Sri Lanka. The per capita income is US $ 1,600. Unemployment which was 8.8 % in 2002 has been continuously declining and is estimated to have reached as low a level as 6.0 %, by the end of 2007.

Inflation, however, has been rising and is now 23.8 % (point to point- end of March) annual average being 17.7%, despite the tight monetary policy stance of the Central Bank, due to both cost push factors and fiscal imbalance with unsustainable deficits. Market interest rates have been increasing having a dampening effect on private investment.

How about the external balance? The current account deficit of the balance of payments which has been increasing as a per cent of GDP since 2002 has taken a slight reverse turn in 2007 (falling slightly from 5.3 % in the previous year to 4.2 % of GDP), with exports rising faster than imports, and worker remittances increasing significantly more than in the previous year. This coupled with the significant increase in the net foreign capital inflow due to the US$ 500 million international bond issue, increased foreign investment in Treasury Bonds (limit now being up to 10 % of the total outstanding stock) and increase in FDI, resulted in an increase in the level of official reserves sufficient to meet more than 3 months of imports. There was also a slight decrease in the external debt as a per cent of GDP to 37.9 % from the previous year’s 38.4%. However, due to the increased net foreign capital inflow, the exchange rate, in terms of the Dollar, which has been depreciating in the first part of 2007 has begun to appreciate since then and has now reached a critical level which is causing concern to the Sri Lankan exporters.

Thus, even though overall, the performance of the economy can be considered favourable, two things are worrying. One is the rising inflation and the consequent rocketing cost of living. Coupled with that is the other, the poverty of a large segment of the people. Even though the annual per capita income is US$ 1,600 now, the inequity of income distribution is so skewed that nearly half (41.6 %) of the population live below the poverty line of US$ 2.00 per day, and even more alarmingly, the bottom 20 % of the income receivers (going by the Central Bank 2003/4 Consumer Finance and Socio-Economic Survey) get less than 4 % of the total income with a per capita average income of around US$ 250 (that is less than US$ 1.00 a day). This inequity and resulting poverty, with more than 15 % of the population considered absolutely poor and a similar proportion malnourished is manifest in their deprivation in regard to facilities such as housing, electricity, sanitation and household equipment.

The lack of access to, and deprivation of, facilities is caused not only by the skewed income distribution but also by the disparaged economic development. The development which has occurred has concentrated in the Western Province and the Colombo district within it. To illustrate, the per capita GDP of the Western province is more than twice as much as that of any other province and is more than 75 % higher than the national average, with nearly 30 % of the total employment and the bulk of the industrial capital of the country engaged there.

If one considers only growth, there may be, in fact, no reason to lament or complain about our present overall performance. A 6 %- 7 % growth with a relatively very low annual population increase of around 1 % accounts for a per capita growth of 5% - 6%. That enables a doubling of the average standard of living every 12-14 years, which is not bad. But the problem is that it does not apply in respect of a considerable segment of the country’s people who live in poverty, as I said before. The problem has become even more serious now in view of the high inflation, because it is these poor people who are worse affected by it. All in all, Sri Lanka’s much bigger problem is inequity and poverty rather than the inadequate growth per se, and this should have been adequately addressed. What is the economic outlook for 2008 and beyond?

The outlook of Sri Lanka for 2008 and beyond depends upon the performance of the global economy as well as the opportunities and challenges directly faced by her domestically. The world economy all round is expected to slow down due to several factors such as the sub-prime mortgage/housing market in the US, rocketing fuel prices and food prices, easing of growth in the Asian Power Houses of China and India in response to overheating of their economies. Even though this slow-down would be arrested to some extent by the sustained productivity improvement among the major players of the globe, the global outlook will not be as favourable as last year. Sri Lanka must bear this in mind in shaping and structuring her own economy, in facing the challenges threatening her, and utilising the opportunities falling before her, in 2008 and beyond .

Domestically, she will continue to face the same challenges in 2008, as she faced in the year 2007, perhaps to a more accentuated degree. For, security concerns will be more serious as the Government is committed to end the terrorist war in the North before the end of the year, and as a result, the security related expenditure will not fall below the budgeted Rs.117 billion, if at all it may increase further. (But this may not be considered as a challenge to the growth of the economy, as strengthened national security will be almost a prerequisite for long-term, sustained development.) The import cost of wheat flour, milk powder and other food items is not going to be any lower this year either- in fact, the food prices may go up further, in view of the impending global food scarcity. The Import cost of a barrel of crude oil has already reached a historically record level of more than US $ 110 per barrel, though the adverse impact of this on the domestic economy would be slightly offset by the depreciating value of the Dollar.

New opportunities have, however, arisen to face these challenges. The liberation of the East is one such opportunity. The overall growth momentum should accelerate with the infrastructure development, and the establishment of the Special Economic Zone (SEZ), and the resurrection of hitherto closed industries, in the East, and the setting up of the IT park at Katunayake. Another opportunity is the heavy investment in both the ongoing and new projects of road development, port, airport, irrigation and power in the rest of the country, financed largely by foreign funds. These infrastructure developments will no doubt enhance Sri Lanka’s low productivity and thereby step up overall growth, in the country as a whole.

The Liberation of the East from the Tiger terrorism, in particular, will help to boost its agriculture as well as manufacturing by bringing under cultivation again the land abandoned hitherto, and the resurrection of industries, such as sugar, paper and mineral sands. The recommencement of fishing in the Eastern seas also will at least offset the shortfall in the fish output in the Northern seas due to acceleration of the war there, if not increase the overall output of fishing in the country..

The GDP or the net output growth of the agriculture sector, as a whole, was zero in 2004. It has since been growing and has been contributing significantly to the growth of the economy with more than 3 % growth last year. With the new emphasis and the new role attached to domestic agriculture (and now with Vaga Sangramaya and Api Wavamu Rata Nagamu programme also in force) in the overall development strategy, the contribution of this sector is likely to increase even further in 2008 and beyond. Increasing global food prices, should, in fact, act as an incentive towards this.

The outlook also seems good for the construction industry. With the ample expertise and skill in structural/construction engineering available in our country, we can build almost a sellers’ market here. Already a boost has been given to it by the signing of the contract for the construction of the 345 million luxury housing project of Rs.13 billion in Qatar and several other projects under negotiation. The output of the construction industry would also be higher in 2008 due to the completion of the large number of high rise condominiums, public servants’(including armed forces and the police) housing and housing for slum dwellers. The construction industry contributed nearly 10% of the growth of the GDP last year. It is likely to be more in 2008 and beyond.

With the establishment of the Tourist Development Authority, tourist arrivals from our conventional markets were expected to increase by 20 % and the earnings by US $100 million in 2008. This is unlikely to happen this year, 2008, in view of the increased violence and terrorism and the escalation of the war, the consequent adverse travel advisories and the labelling of Sri Lanka as a high security-risk zone. Any shortfall due to this, however, may be offset by the expected emergence of the Gulf market comprising high spenders. The situation will hopefully improve further in 2009 with the eradication of terrorism. In any case, the contribution by the entire tourism sector to the overall GDP of the country at present is less than 1 %, and therefore, is not going to have a significant impact, either way, on the overall growth.

Another redeeming feature for the future economic outlook is the trend of increasing worker remittances and foreign funding. Workers’ remittances have, in fact, doubled in 2007 from its US$ 1.287 billion in 2002. This trend will continue and would help to improve both the current account deficit and the overall surplus in the balance of payments, and thereby having a cushioning effect on the external debt and the debt service ratio.