Can the Sri Lankan economy sustain its high growth of 8 per cent achieved in 2010 this year too? The Central Bank thinks the rate of economic growth could be enhanced to a somewhat higher growth of 8.5 per cent this year. This expectation is perhaps based on the 8.6 per cent growth rate achieved in the fourth quarter of 2010. However, sustaining such a high rate of growth is an uphill task requiring a global economic upturn, a better investment climate, favourable terms of trade and good weather.
The IMF and the ADB are more cautious in their estimates. Both these institutions expect an economic growth of 7 per cent this year. Even this is a challenging task after an 8 per cent growth last year and a global context that is not wholly propitious. The increase in fuel prices, the economic shock of the Japanese earthquake and tsunami and the unrest in the Middle East are likely to affect the Sri Lankan economy adversely.
An uphill task
Sustaining an 8 per cent growth is not an easy task as several current conditions are detrimental to achieving higher growth this year. First of all there is the very important difference between a recovery from low growth and the continued growth from a high economic growth base. The growth of 8 per cent was on a rather low production base in 2009, when the economy grew by only 3.5 per cent. Last year’s growth in all three sectors was high partly because the 2009 output was relatively low. It is more difficult to get a high rate of growth from the high level of production in 2010. This is not only a statistically difficult task, but a tough economic achievement.
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There are certain developments, both locally and internationally, that will impede growth this year. In fact the high growth rate of 8.6 per cent in the last quarter of 2010 is not likely to be sustained in the first quarter of this year as unfavourable weather conditions affected agricultural production. Growth in the agriculture sector is likely to be adversely affected by weather conditions in the first months of this year.
The Maha crop of paddy is estimated to be about 30 per cent less. A similar drop in other crops has also occurred. Tea production too declined in the first quarter. However the impact of these on the growth rate would be minimal as total agricultural production, including fishing, forestry and livestock, accounted for only 12 per cent of GDP. Therefore the decline will affect GDP only to a limited extent, especially if production of food crops and tea revives in the second half of the year.
Realistic growth
Even an achievement of an economic growth of 7 per cent would be creditable for several other reasons. These include: the soaring international oil prices at around US $ 120 per barrel; the increasing domestic inflationary pressures; the impact of the Japanese disasters on the global economy that is expected to decelerate economic growth worldwide; reduced worker exodus to the Middle East resulting in slowing down of remittances; and the likelihood of earnings from tea decreasing due to decreased demand and lower tea production. There are favourable factors as well: the continuation of the peaceful conditions, increasing tourist arrivals, increasing business confidence and the impact of infrastructure development on growth statistics. Nonetheless on balance, the achievement of an 8 per cent growth this year is a rather optimistic expectation.
International environment
Being an export-import economy international economic conditions encroach on the Sri Lankan economy in many ways. One of the most serious setbacks to the economy is the rising prices of oil in the international market. Crude oil prices have risen to around US$ 120-125 per barrel. This has serious repercussions on the Sri Lankan economy. Most directly it affects import expenditure causing a big dent in the trade balance. In 2010 too the increasing oil, fertilizer and food bill resulted in a record trade deficit of U$ 5.2 billion. The trade deficit this year is likely to be much higher owing to the increasing price of oil. Indications are that the trade deficit would peak to about US$ 8 billion, even with increased industrial exports.
Increase in fiscal deficit
The fiscal implications of the high oil prices are severe. Part of the increase in oil prices has been passed on to consumers in higher consumer prices of petrol, diesel, kerosene and gas. The consumption of these is not likely to decrease to any significant extent due to this marginal increase in price. Consequently there would be an increase in import expenditure. It is mainly because of this expenditure that the trade deficit is likely to be huge.
Besides this, if the high oil prices are not passed on to consumers, it would result in a larger fiscal deficit. The Ceylon Petroleum Corporation (CPC) will incur a higher loss that would have to be met by a government subsidy. The cost of generating eletricity will also rise. There were favourable weather conditions that enabled a higher proportion of electricity to be generated by hydro-electric plants. The lesser rainfall and higher oil prices would result in further increases in electricity generation costs. If these are not passed on to consumers, then the Ceylon Electricity Board (CEB) would suffer heavy losses that would have to be borne by the government. This would once again increase government subsidies to loss making corporations that have been one of the important reasons for the high fiscal deficits. One of the significant gains last year was the bringing down of the fiscal deficit to 7.8 per cent of GDP. These factors may lead to a worsening of the fiscal deficit once again, unless countervailing measures are taken to reduce government expenditure.
The international economy
The global recovery that was on its way to a recovery has had another setback owing to the Japanese disasters of an earthquake followed by a tsunami. The global economy is expected to retard somewhat. The US economy is not likely to grow by more than 2 per cent. The international demand for several commodities is likely to be affected. The Japanese demand for oil would increase and tend to keep oil prices up. Although motor car production was initially expected to decrease, the fact that much of car production is outside Japan, may result in a lesser effect on motor car production and therefore the demand for rubber may not be adversely affected. International rubber prices are expected to be high owing to the increase in oil prices that would increase costs of synthetic rubber manufacture.
Likely outcome
The course of international economic events and their repercussions are difficult to predict. However it is most unlikely that they would be favourable. Further, the investment climate in Sri Lanka is not yet one conducive to high levels of foreign investment in industry, even though large investments in the hospitality trade is evident.
The government’s commitment to a market economy is being questioned owing to the effort of the government to regain control of strategic business enterprises, especially banks, through investment of state controlled agencies.
The initial boost to the economy from peace and the access to resources in all parts of the island and smooth internal trade flows will continue to contribute to the national output of goods and services. However, their impact on the GDP may be less striking than in 2010. Considering all these factors it would be an achievement to realize an economic growth of even 7 per cent this year. Sustaining high economic growth is a challenging task.
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