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Cessation of war should lead to economic growth

The 6 % growth of the last year is accompanied by signs of a deteriorating and crisis ridden economy. This  year’s economic growth is expected to decline precipitously to less than half that of last year’s growth, amidst growing problems of a weakening currency, high fiscal deficit and balance of payments problems. The only hope lies in a resurgence of the economy owing to the cessation of the war that has plagued the economy for more than two decades.  This hope amidst despair is expressed clearly in the Central Bank Annual Report for 2008.

The economic growth of 2008 was better than expected in a crisis ridden economy and country. The growth was mostly achieved in the first half of the year and to a lesser extent in the next three months. The fourth quarter of the year reflected the impact of the global recessionary conditions as well as poor management of the exchange rate in the evolving global conditions and continued high public expenditure. In the first nine months of the year the economy grew by 6.5%but growth decelerated to 4.3% in the last quarter of 2008. The Central Bank observes that all sectors of the economy contributed positively to growth in 2008.

The Agriculture sector was the main contributor to the growth in 2008. Agriculture and Fisheries grew at a higher rate of 7.5%. This is attributed by the Central Bank to higher commodity prices in the first half of the year and the “re-awakening of the Eastern Province”. However, the Agriculture sector contributes only 15% to GDP. In 2008, the agriculture sector reflected a diverse performance with a positive contribution to economic growth. Paddy, sugar, fish and rubber production increased substantially. The Bank comments that the “remarkable growth of paddy production was attributable to an increase of the extent of lands cultivated due to high farm gate prices for paddy, the liberation of the Eastern Province, and the effect of the government national programme to increase domestic agriculture production.” Tea production that was buoyed by high prices faced a ‘sharp turnaround of tea prices at the Colombo tea auctions in the latter part of the year and the measures adopted to arrest the falling prices caused production to decline significantly towards the end of the year.’ The tea industry, both the estates and small holdings, are in a state of crisis and may not perform well this year.

The industrial sector that contributes nearly twice the contribution to GDP of agriculture at 28% grew by only 5.9% compared to a growth of over 7% in 2007. The Industrial sector that grew by over 6% in the first nine months recorded a 5.9% growth owing to the declining demand for many manufactured exports. Industries faced the twin problems of declining prices and higher costs of production.

onsequently growth in manufacturing decelerated to only 5.2% in the fourth quarter. Textile, wearing apparel, rubber, plastic and leather products experienced a deceleration due to the slowdown in the external demand. The ceramic industry suffered severely ‘mainly due to the high cost of production arising from increased raw material and energy cost, decreased demand for wall tiles from the construction sector and low demand for tableware from the EU and the United States.’
The services sector that has been the main source of growth in recent years and accounts for 57% to overall growth decelerated with all its sub-sectors recording slower growth compared to the previous year. The Central Bank attributes the slowdown mainly to the deceleration in export trade, transport and financial services. However, import trade, and post and telecommunication, which are components of the wholesale and retail trade sub-sector, and the transport and communication sub-sector, respectively recorded expansions at higher rates. The slowdown in export trade was due to the global recession. The growth in the telecommunication sector was largely supported by the expansion in the coverage as reflected by the increased telephone density. Owing to these factors the Services sector decelerated to a growth of 5.6% down from the previous year’s growth of around 7%.

The declining trend in the economy is clear. What the Central Bank Annual Report failed to state is that fundamental weaknesses in the management of the economy were added reasons for this decline apart from the global recession. Placing the blame on international factors without adjustments in economic policy cannot help. At least the Bank has been realistic in expecting the growth in the economy to fall sharply to 2.5%.

The Central Bank says: “The Sri Lankan economy has now come to a historically important juncture with the recent domestic and external developments. The ending  of the three decades long conflict resulting in a greater integration of the Northern and the Eastern Provinces with the rest of the country on a permanent basis and new opportunities that will be created with the expected recovery in the global economy would place the country on a better platform to move along a higher growth path. Increased access to the enormous amount of untapped resources in the Northern and Eastern provinces will enhance the country’s growth potential while the integration with other provinces would provide a significant boost to the economy, mainly through the expanded markets, better utilisation of natural and human resources and proper direction of talent and innovation.”

It expects the end of the war to bring about conditions conducive to development and the registering of higher economic growth. The Bank is of the view that peaceful conditions would enhance foreign and private domestic investments and that there would be assistance from development partners. The Bank looks at the current recessionary conditions in the global economy as one that requires the private sector to adjust their businesses to better face the crisis situation, introduce changes to their business models and management practices to improve productivity. It also reflects on the need for the public sector too “to re-think and re-orient its policies and strategies to cope with the unfolding situation.”

There are several weaknesses in this expectation. First, the amount of assistance the country would receive may not be as large as one may have expected some years ago owing to the recessionary conditions in the developed world. Much if the assistance may have to come from Asian countries namely China and India. Theses two countries have reserves that they may be willing to use to help the country’s reconstruction efforts. Much of the assistance may also be conditional to a reasonable settlement of the ethnic issues and a constitutional settlement that is acceptable to the minorities. The government has made little headway in this direction. Beside this there may be conditions about the human rights situation that is deteriorating rather than improving. For this reason the excessive reliance on foreign assistance may be somewhat misplaced. Nevertheless there can be no doubt that the end of hostilities and a durable peace would bring about an impetus for economic growth in the North and East that would have beneficial repercussions on rest of the economy.

The other set of factors that would have an important impact would be how the weaknesses in the economy would be handled. These include the containment of the fiscal deficit, the adoption of a realistic exchange rate that would be conducive to the expansion of the country’s agricultural and manufactured exports. There has already been a depreciation of the currency. The expectation is that this depreciation would reach the correct level through market correction and then remain relatively stable. The control of inflation would be vital to the attainment of the economic objectives. Again the control of wasteful public expenditure and thereby controlling the fiscal deficit would be essential. This will not be an easy task as there would be several forces that exert inflationary pressures. Such inflationary pressures would arise from the depreciation of the currency and increased development expenditure for the North and East of the country. These makes fiscal discipline all the more difficult. The expectation of higher revenues would be also difficult when, for most part the recessionary conditions and problems in several areas of economic activity are becoming less profitable. The economy can perform better or worse than the expectations. The set of policy reforms to be adopted would determine the outcome.