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News Features  


 

WILL ECONOMY’S GROWTH BE AFFECTED BY RECENT FLOODS?

The two waves of floods that devastated the Maha crop, roads, bridges and houses in the Eastern Province and North Central region could be a setback to the country’s economic growth. The International Monetary Fund (IMF) is however of the view that the Sri Lankan economy is on a path of high growth despite the recent set back of the floods in parts of the country. It is of the view that the floods would not result in much of a slowdown in the economy though the rate of inflation would however rise this year owing to higher food prices owing to the crop damage and higher international prices of food and oil.
Even more important is their evaluation that economic policies are in the right direction and that the fiscal deficit is likely to be within targeted amounts though there are some weaknesses in the economy, such as in the area of public debt and the trade balance. The large inflows of remittances on the other hand, are a strength to the balance of payments.

Economic growth
The IMF estimate of economic growth of 7.75 percent for 2010 is slightly less that the Central Bank estimate of 8 percent. The expectations that the economy would grow at 8 to 8.5 percent were optimistic as indications are that when the 4th quarter growth estimates are in, the annual rate of growth would be around the 8 percent level. This is a good recovery from the 3.5 percent growth of 2009.
However, it was relatively easy to record an 8 percent growth from the low base of 2009. It would be more difficult to keep the momentum of growth going in 2011 and after. The IMF statement did not give a precise estimate of growth for 2011 but did note that the recent floods would not have that much of a depressing impact on growth. In fact the manner in which GDP statistics are computed is such that the reconstruction of the devastation itself will count towards increasing the GDP.
The external environment would be an important determinant of Sri Lanka’s growth due to both supply and demand factors. The unrest in the Middle East is a potential source of instability through its impact on oil prices that are fluctuating on an uptrend. On the one hand the prices for tea and rubber are at peak levels. The recovery of the international economy is vital for the country’s exports. There has been some improvement in export performance at the end of last year that requires to be sustained to ensure that the trade deficit is not widened.

Impact of floods
The IMF view is that while the recent floods did cause serious damage to a few regions of the country, its effect is basically temporary. The IMF statement said: “Recent flooding has significantly damaged Sri Lanka’s harvest of various crops including rice and vegetables, as well as rural infrastructure. Any effect on food prices is likely to be temporary, and given the strength of the Sri Lankan economy, the overall impact on output growth should be limited.” The IMF wording was cautious and must be interpreted carefully. It said the impact on output growth rather than the broader implications for society affected by the floods and poverty in the region.
Moreover, this IMF perception is based on official suppositions that have underplayed the impact of the damage. About 40 percent of the rice crop is estimated to have been lost, besides vegetables and other pulses and grains.The loss of the crop would also affect the capacity of farmers to cultivate the Yala crop unless government assistance is adequate to provide the necessary capital for inputs like fertilizer, agrochemicals, hired labour and tractor charges, the cost of all these being likely higher in the next season. The other serious problem is the adequacy of seed paddy. Given these disadvantages the impact on the economy may be more serious than that assessed by the IMF.

Fiscal implications
Some economists have drawn attention to the fiscal downside of the damage. On the one hand there was a need for extra finances for the rescue, rehabilitation and reconstruction, and on the other hand there is a need for additional finances meeting the difficulties arising from the loss of crops such as increasing imports without tariffs and providing subsidies. These, it was thought would result in additional expenditure or decreased revenue that would increase the fiscal deficit.
The IMF is hopeful that a reallocation of funds supplemented by international assistance would enable the government to keep to the budgeted estimates of expenditure and contain the fiscal deficit to the targeted 6.75 percent of GDP in 2011. The IMF statement states that: “Addressing the impact of the floods may require some reallocation of budget resources, but the authorities feel that it is premature at this stage to revisit their targeted deficit for 2011 of 6¾ percent of GDP.”

The principle enunciated that any additional expenditure should be from a reallocation of funds already earmarked for other expenditure is sound. This would be particularly so if the expenditure is reallocated from a low priority and low or unproductive area of activity. In fact there is much scope for such deployment of funds. If in practice this principle of reallocation is not followed, then the usual overrun in expenditure would occur and the containment of the fiscal deficit to 6.75 percent of GDP will not be possible. Then it would be a setback to the process of fiscal consolidation that would reduce the public debt and debt servicing costs.

Towards fiscal consolidation
The country is on its way towards fiscal consolidation according to the International Monetary Fund. This is perhaps the most important economic news of recent months. There were several figures disclosed at the press briefing that indicated that with their knowledge of the latest statistics and approaches of the government, that the IMF was of the view that the fiscal deficit would be brought down this year after meeting the target of a 7.5 percent of GDP deficit target for last year. If the fiscal deficit is brought down to 6.75 percent this year, there would be a gradual reduction of the public debt and debt servicing cost. The gradual reduction of public debt and servicing costs would strengthen the stability of the economy and be conducive to higher growth.

Conclusion
The hope and expectation for the nation is that the flood damage will not have a permanent set back to the economy; that international factors would not be unduly unfavourable; and that the fiscal deficit is contained at the targeted levels to ensure economic stability and growth.