Economic growth drops in 2015; blame on export slowdown and exit of foreign funds
View(s):The Central Bank in its 2015 Annual Report released on Tuesday pinpoints the economic difficulties encountered by the country last year. They include growth slowdown, inflation pick-up, fiscal imbalance, debt commitments, dampened national savings and balance of payments deficit.
The budget deficit jumped to 7.4 per cent of GDP in 2015 as against the targeted deficit of 4.4 per cent. The balance of payments recorded an overall deficit of US$1.5 billion resulting in a depletion of foreign reserves. The core inflation rose to 4.5 per cent by the end of the year.
Coherent policy framework lacking The Annual Report presents a long list of reforms that are needed to tackle the current economic problems.
The suggested reforms cover a range of areas including fiscal consolidation, revival of failed state-owned enterprises, external competitiveness, inclusive growth, human capital, education, health, public transport, renewable energy, agricultural productivity and financial deepening.
Unquestionably, these reforms are critically important to overcome the economic problems. However, it is not clear how such fragmented proposals could be translated into a time-bound policy framework. In its policy analysis appearing in Chapter 1, the Report makes no reference to the Economic Policy Statement announced by the Prime Minister in the Parliament in November last year, which was supposed to be the economic roadmap in the medium term.
The Report in its policy analysis does not elaborate on the government’s flagship project Megapolis, although it was referred to in an earlier part of Chapter 1. Debt-funded economic growth unsustainable The year 2015 saw deceleration of economic activities manifested by the global economic downturn and domestic setbacks. The GDP growth declined to 4.8 per cent in 2015 from 4.9 per cent in 2014. The government-sponsored infrastructure projects funded by foreign borrowings helped to maintain high economic growth until about 2012. The economic growth thus generated by debt-funded projects was not sustainable for long as the country experienced difficulties in attracting foreign loans amid capital outflows following the US Fed rate hike in December last year.
Service-related growth bubble Service-related activities have been the major driver of economic growth accounting for 63 per cent of GDP growth in 2015. The contribution of the manufacturing sector was only 16 per cent and agriculture only 9 per cent. While the service sector growth is quite common when countries graduate to higher scales of development, a deeper analysis of the sources of growth reveals the fragility of economic growth in Sri Lanka. The contribution to GDP growth came mainly from financial and trading activities in the services sector. Financial, insurance and real estate activities contributed as much as 30 per cent of GDP growth in 2015 while trade, transport, accommodation and food services contributed 23 per cent.
The low interest rates prevailed for a long period creating a credit bubble and fostered trade and finance-related activities. Importation of vehicles and real estate businesses has been thriving due to low interest rates without reinforcing the long-term growth trajectory. The shift of financial resources to trading and speculative activities was reflected in the decline of domestic savings last year. ’Wait and see’ monetary tightening
The Central Bank is somewhat reluctant to tighten its monetary policy which remains relaxed since 2012. The monetary tightening adopted early this year was limited to a 50 basis point increase in the policy rates and a marginal increase in the Statutory Reserve Ratio. Low interest rates have fuelled demand pressures causing a rise in core inflation.
The Monetary Board at its recently held meeting, however, decided to keep the policy rates unchanged. The low interest rate policy has had many adverse consequences on the economy, as rightly pointed out by economist W.A. Wijewardena in his Daily FT column last Monday. Reform agenda yet to be announced The external debt problem remains to be addressed. The government does not have any option other than to roll over the debt so as to meet the external debt commitments. Export earnings are sufficient to finance only one half of import payments compelling further foreign borrowings. The recent credit rating downgrade for the country by the rating agencies made a further dent in external finances.
On the fiscal side, the increasing budget deficit aggravates the debt burden.
The recent tax revisions including the increase in VAT rate seem to be ad hoc measures rather than broad-based tax reforms. No action has been taken to raise direct taxes, though it was mentioned as a priority area in the PM’s policy statement. The inevitable expenditure cuts are also not forthcoming. There doesn’t seem to be a firm commitment on the part of the government to launch a robust reform package to deal with the macroeconomic imbalances. Given the contrasting ideologies within the coalition government amid outside pressures, it would be rather difficult to implement a rigorous reform package which may have political disadvantages.
It is speculated that the proposed $1.5 billion bail-out package from the IMF would compel the government to implement the much delayed reforms. Meanwhile, the government has sought financial assistance from the Chinese government to ease the external finance pressures. As such bilateral arrangements do not have any conditionality pertaining to structural adjustments, resorting to such assistance might further delay the IMF-style reform process thus, leading to aggravate the economic imbalances.
(The writer, an economist, academic and former central banker, can be reached at
sscolom@gmail.com)
| Central Bank retains interest rates amidst speculation of a hike | |
| Sri Lanka’s Central Bank (CB) on Tuesday kept interest rates unchanged contrary to expectations by the money market of a possible hike to stem inflation. “Considering the fact that the Central Bank has already adopted measures to tighten monetary policy by raising the Statutory Reserve Ratio (SRR) and policy interest rates, and that the impact of these measures is yet to be reflected in monetary conditions in full, the Monetary Board, at its meeting held on April 26, was of the view that the current monetary policy stance is appropriate and decided to maintain the Standing Deposit Facility Rate (SDFR) and the Standing Lending Facility Rate (SLFR) of the Central Bank unchanged at 6.50 per cent and 8 per cent, respectively,” the bank said in a statement. The statement said that headline inflation, as measured by the Colombo Consumers’ Price Index declined to 2 per cent on a year-on-year basis in March 2016 from 2.7 per cent in February 2016, mainly due to the decline in food inflation. On an annual average basis, CCPI based headline inflation edged up to 1.1 per cent in March 2016 from 0.9 per cent in the previous month. Year-on-year headline inflation was 2.2 per cent in March 2016 compared to 1.7 per cent in the previous month, and was 2.4 per cent on an annual average basis. Credit granted to the private sector by commercial banks increased by 26.5 per cent in February 2016, on a year-on-year basis, compared to 25.7 per cent in January 2016, while in absolute terms, credit granted to the private sector grew by Rs. 53.7 billion during the month of February 2016. Meanwhile, market interest rates have risen reflecting the tight monetary conditions in the economy. Going forward, a gradual slowdown in money and credit expansion is expected in the period ahead, as the recent monetary policy measures are expected to have an impact on the economy with some time lag. “On the external sector, the decline in expenditure on imports in February 2016 has been greater than the decline in earnings from exports, thereby narrowing the deficit in the trade account by 11.7 per cent, year-on-year. Earnings from tourism are estimated to have increased by 22.8 per cent in March 2016, while workers’ remittances recorded a healthy increase of 8.3 per cent in February 2016. Gross official reserves are estimated to have stood at US$ 6.2 billion by end March 2016 compared to $ 6.6 billion at end February 2016, and the Sri Lanka rupee remained broadly unchanged against the US dollar thus far during 2016. |