The Central Bank (CB) is forecasting 3.5% growth in 2009 for Sri Lanka’s domestic with a higher growth trajectory expected for 2010 which augurs well for the outlook of the financial services industry and financial system stability. According to the Financial System Stability Review for 2009 released by the CB this week, economic growth in Sri Lanka slowed down to 1.8% in the first half of 2009 compared with 6.6% in the first half of 2008, primarily due to the negative impact of the global recession on the external trade sector with exports and imports contracting by 18% and 35% respectively.
The financial services sub-sector moderated to 4.5% in the first half of 2009 compared with 6.8% in the same period in 2008. A positive sign is that the growth momentum is beginning to pick up, as indicated by the second quarter data, the Review stated. It added that several factors are contributing towards creating a conducive environment for the expansion of economic activities and improving investor confidence such as the global recovery which will stimulate the growth of the export sector, the implementation of reconstruction and development programmes in the two provinces that affected by the conflict, the deceleration in inflation and the decline in interest rates.
Inflation is expected to be contained at single digit levels in 2010 according to the CB. The rate of inflation measured by the point to point change in the Colombo Consumers Price Index (CCPI) declined rapidly during 2009 from 14.4% in December 2008 to 0.7% in September 2009. The Review states that the reduction in inflationary pressures is a consequence of the monetary policy measures taken by the CB, the decline in commodity prices in international markets and favourable domestic supply conditions in the food crop sector. The average inflation rate for 2009 is expected to be around 5% and inflation is forecast to be low and stable in 2010.
The balance of payments and external reserve position has improved in 2009 according to the Review. Although export earnings declined by 17% during January to August 2009 due to the global recession, expenditure on imports declined by a greater proportion of 35%. Consequently, the trade deficit narrowed significantly by 60%. Private remittances continued to grow strongly by about 10% and more than offset the trade deficit. The current account deficit is expected to decline to 1.2% of the GDP in 2009 from 9.3% in 2008. The balance of payments surplus is forecast at US$2.8 billion for 2009. The external reserve position has also improved considerably.
The CB said the domestic financial markets in Sri Lanka which were somewhat volatile at the beginning of 2009 became more liquid and stable in the second half of the year with the declining inflationary pressures and the easing of monetary policy, resumption of capital inflows due to reduced risk aversion and improved investor sentiment following the end of hostilities. However, Sri Lanka’s financial system remained resilient weathering the domestic economic slowdown caused by the global financial crisis and recession, and amidst stresses due to the failure of some entities engaged in unauthorized finance business.
According to the Review, the outlook for financial system stability is positive in view of the more favourable macroeconomic developments. Economic growth is forecast to move upwards with renewed investor confidence following the cessation of hostilities and the reintegration of the Northern and Eastern Provinces into the national economy and the reconstruction of the conflict affected areas. The recovery of the global economy and the decline in domestic inflationary pressures and interest rates will improve the prospects of the business sector and expand opportunities for financial institutions. Nevertheless, it is important that financial institutions practice good corporate governance and prudent risk management to improve their soundness and resilience.
According to the CB, the domestic banking institutions maintained their soundness with adequate levels of earnings and improved risk management systems within a strong regulatory framework. The CB said it took immediate and decisive measures to rescue a systemically important bank which experienced deposit withdrawals due to the failure of an unregulated credit card company in a large financial conglomerate to which it was affiliated. The bank was successfully recapitalized and is conducting normal business operations.
The review states that the finance and leasing company sector is beginning to rebound from the stresses experienced due to the failure of some entities which engaged in unauthorized finance business. The CB and the Ministry of Finance intervened to assist the distressed companies and to rebuild confidence in the sector. The insurance sector remains stable with companies complying with solvency margin requirements. The systemically important payment and settlement systems operated with a high degree of availability and safety, with progress being made to regulate electronic payment instruments and to modernize the retail payment system.
The Review says steps are being taken to contain the fiscal deficit. The Budget 2009 estimated the fiscal deficit to be 7% of GDP in 2009. A further reduction in the fiscal deficit is expected in 2010. The proposed reduction in defense and security related expenditure and the decline in interest costs of servicing public debt will contribute towards lowering the deficit. A Tax Commission has also been formed to review the current tax policy and to make recommendations on broadening the tax base, strengthening tax collection and simplifying the tax system. |
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