Higher economic growth of 7% to 8% is expected in Sri Lanka in the medium term by the Central Bank (CB) after moderate growth of 3.5% in 2009, facilitated largely by an improved macroeconomic environment, increased investor confidence and new investment opportunities. The Director of Economic Research at the CB K. D. Ranasinghe said several major infrastructure projects will be implemented and the global economy is expected to recover.

At a presentation on the CB’s 2009 Annual Report this week (after it was released on Monday), Mr. Ranasinghe said the relatively low level of government revenue underscores the need for strengthening the tax system. Appropriate steps should be taken to simplify the tax system such as setting out proper tax rates, broadening the tax base, reducing and rationalizing tax concessions and exemptions and improving tax administration. He said an efficient tax regime will encourage private sector economic activity and capital formation.

Mr. Ranasinghe also said the efficiency of state owned enterprises (SOE’s) have to be improved. Structural and institutional improvements already identified need to be implemented. He underscored the importance of SOE’s operating on a cost recovery basis while improving efficiency to reduce their reliance on the government budget.

Public confidence in the financial sector has to be strengthened through the establishment of a mandatory deposit insurance scheme (MDIS) which would contain the cost of resolving failed banks and provide an effective mechanism for dealing with bank failures. Mr. Ranasinghe said a deposit insurance scheme also complements the prudential regulation and lender of last resort facility.

He added that private sector participation in infrastructure development can be promoted through Public Private Partnerships (PPP’s) in order to fast track projects and ensure maintenance and management in a sustainable manner. It will also reduce the burden on the government budget in financing infrastructure.

Mr. Ranasinghe said creating an Export and Import (EXIM) Bank will be crucial to promoting the country’s international trade in goods, services and investment though facilitation and financial assistance. He added that it will play an important role in integrating the Sri Lankan economy with the global economy.
He also said the Small and Medium Enterprises (SME) sector need special attention as it makes a significant contribution to the economy. A number of measures including refinance schemes have been introduced to assist SME’s. Further, it has been proposed to establish a credit guarantee scheme to ease SME financing constraints, allowing greater access to bank finance at competitive rates.

Real sector
The Sri Lankan economy grew moderately at 3.5% in 2009 after four consecutive years of over 6% growth. The economy which was projected to grow at only 2.5% last year made a steady recovery since 2Q09 where growth picked up to 6.2% in 2Q04. Mr. Ranasinghe said there was a challenging domestic and external environment in 2009 due to the global financial crisis and economic recession, intensification of the war and drought conditions which resulted in tea and paddy output decline.
Mr. Ranasinghe said all sectors recorded moderate growth compared to 2008. The electricity, gas and water, hotels and restaurants and government services sectors recorded higher growth while tea, rice and the wholesale and retail trade sectors recorded low growth.

The savings-investment gap in 2009 as a percent of the GDP narrowed to -0.7% from 9.8% the previous year. Unemployment rose marginally to 5.7% from 5.4% in 2008. Mr. Ranasinghe said that although lower economic activity increased unemployment, it declined with the recovery. However, unemployment among educated young was above 10%.

Mr. Ranasinghe attributed the decline in inflation during 2009 to the tight monetary policy adopted by the CB during the last two years and the decline in global commodity prices. Inflation which reached a high of 28.2% in June 2008 declined sharply to 4.8% by end 2009 while average inflation during the year was 3.4%, the lowest since 1985.

External sector
Mr. Ranasinghe said the external sector experienced a downturn until the end of 1Q09 due to a sharp outflow of foreign investments, the non-rollover of short term debt, drying up of new commercial financing, servicing of higher petroleum bills, pressure on the exchange rate and a decline in official reserves. However, the sector rebounded strongly in the second half of the year due to the end of the conflict and increased investor confidence which resulting in the highest level of reserves by end 2009.
Earnings from exports declined by 12.7% while expenditure on imports declined by 27.6%. The trade deficit contracted by 48% to US$3,122 million in 2009 compared to the 64% expansion to US$5,981 million in 2008.

Mr. Ranasinghe said remittance inflows were more than sufficient to offset the trade deficit. Workers’ remittances grew by 14.1% to US$3.3 billion in 2009. Remittances were US$208 million (6.7%) above the trade deficit and the current account deficit narrowed to 0.5% of GDP in 2009 from 9.5% in 2008.
Foreign Direct Investments (FDI’s) decreased to US$601 million compared to US$889 million in 2008, mainly due to the global financial crisis. Foreign financial inflows to the government increased during the second half of the year.