The 63rd Annual Report of the Monetary Board was submitted to the President of Sri Lanka and Minister of Finance and Planning last week. Following are some of the highlights of the report.
The Sri Lankan economy grew at a healthy rate of 6.4 per cent in 2012 while inflation was maintained at single digits for a fourth consecutive year, despite several global and domestic challenges. Improved business and consumer confidence, which supported a robust economic growth of 8 per cent in the preceding two consecutive years, was accompanied by high credit and monetary expansion and a widening trade deficit fuelled by high import demand.
Inflation was maintained within single digit levels in 2012 for the fourth consecutive year. Inflation declined to a low level of 2.7 per cent in February 2012. By end 2012, the annual average rate of inflation stood at 7.6 per cent. Import expenditure declined by 5.4 per cent with non-fuel imports declining at a faster rate of 8.6 per cent. Despite the decline in exports by 7.4 per cent due to weak external demand and the decline in international commodity prices, the trade deficit contracted to 15.8 per cent of GDP in 2012. The improvement in the trade account, increased inflows from trade in services including tourism and transportation, and continued high growth in workers’ remittances helped contain the current account deficit to 6.6 per cent of GDP in 2012. The improvement in the current account together with higher inflows to the capital and financial account from the proceeds of the fifth international sovereign bond, higher inflows to the government to finance infrastructure development projects and increased foreign borrowing by commercial banks and the private sector as a result of the relaxation of exchange control regulations, resulted in the BOP recording a surplus of US dollars 151 million in 2012. Accordingly, gross official reserves rose to US dollars 6.9 billion by end 2012.
The Industry sector was the main driver of growth with the construction sub sector making the most significant contribution, reflecting the massive public investment program and several private sector real estate projects. The Agriculture sector grew by 5.8 per cent in 2012, recovering from a slow growth of 1.4 per cent in 2011, amidst drought conditions in the third quarter of the year and heavy monsoonal rains and floods in the latter part of the year.
The Industry sector grew by 10.3 per cent, contributing substantially to the expansion of the economy in 2012.
Services sector growth moderated to 4.6 per cent in 2012 from an expansion of 8.6 per cent in 2011 mainly due to the deceleration in the wholesale and retail trade sub sector. As a result, the relative share of the Services sector in GDP reduced to 58.5 per cent in 2012 from 59.5 per cent in 2011. The wholesale and retail trade sub sector grew by a modest 3.7 per cent in 2012 from 10.3 per cent in the previous year. The slowdown in import trade, reflecting the impact of policy measures taken to curb imports, and the decline in exports due to the sluggish recovery in the global economy largely contributed to the deceleration in this sub sector.
The lower growth in consumption expenditure mainly on account of imports resulted in an increase in the domestic savings rate to 17 per cent of GDP in 2012 from 15.4 per cent of GDP in 2011. However, there was deterioration in government dis-savings during the year. The continued growth of private remittances from abroad raised the overall national savings rate to 24 per cent of GDP in 2012 from 22 per cent of GDP in 2011. Hence, despite the increase in investment as a percentage of GDP to 30.6 per cent, the savings-investment gap as a percentage of GDP, improved to 6.6 per cent in 2012, from 7.9 per cent in 2011.
Earnings from exports contracted by 7.4 per cent in 2012.Industrial exports declined by 7.8 per cent mainly due to the reduction in textiles and garments, which has the largest share (around 40 per cent) in total export earnings, by 4.8 per cent. The sharp decline in international cotton prices from the peak levels recorded in March 2011 also resulted in a drop in the average unit price of garments. Garment exports to EU, which constituted approximately 50 per cent of total garment exports, declined by 9.2 per cent in 2012, while garment exports to the US, Sri Lanka’s second largest market for garments, also declined by 4 per cent in 2012. Earnings from agricultural exports declined by 7.8 per cent in 2012. Earnings from tea, which accounts for about 15 per cent of total earnings from merchandise exports, declined mainly due to geo-political tensions that continued to hamper demand from some Middle Eastern countries.
Expenditure on imports in 2012 declined by 5.4 per cent, year-on-year, while that on non-fuel imports, declined at a faster pace of 8.6 per cent. As a consequence of the higher import tariff imposed on vehicle imports and the depreciation of the rupee, expenditure on imports of motor vehicles declined by 43.8 per cent to US dollars 495 million in 2012, in contrast to the sharp increase recorded in 2011. This largely contributed to lowering expenditure on the importation of consumer goods in 2012. Expenditure on intermediate goods imports declined in 2012, mainly as a result of lower expenditure on the importation of gold. However, the expenditure on petroleum products increased due to higher dependence on thermal power generation. Also, the continuing US sanctions against Iran curtailed Sri Lanka’s import of crude oil for its refineries, resulting in higher imports of refined petroleum products at a relatively high cost partly contributing to the increased expenditure on petroleum products during the year. Investment goods imports increased with continued development activities in the country in 2012. In absolute terms, the decline in import expenditure was much higher than the decline in export earnings, reflecting the effectiveness of concerted policy measures adopted to reduce import expenditure. As a result, the trade deficit declined from 16.4 per cent of GDP in 2011 to 15.8 per cent of GDP in 2012.
Remittances by migrant workers increased by 16.3 per cent to US dollars 6 billion during the year, continuing to be the largest single source of foreign exchange inflows to Sri Lanka. The improvement in the trade balance and increased inflows from trade in services and current transfers helped restrain the current account deficit of the BOP. Accordingly, the current account deficit was contained at US dollars 3.9 billion (6.6 per cent of GDP) in 2012 from US dollars 4.6 billion (7.8 per cent of GDP) in 2011. In the capital and financial account, inflows to the private sector as well as to the government were substantial in 2012. The narrowing of the external current account deficit and increased inflows into the capital and financial account resulted in a surplus in the BOP, amounting to US dollars 151 million in 2012, thereby boosting external reserves of the country.
The fiscal policy strategy in 2012 focused on strengthening the fiscal consolidation process while maintaining a high level of investment to facilitate sustained economic growth. Accordingly, the budget deficit for 2012 was targeted at 6.2 per cent of GDP with revenue (including grants) and expenditure and net lending as a percentage of GDP, set at 15 per cent and 21.2 per cent, respectively. However, budgetary operations during the year became challenging in an environment of high interest rates, rising debt service payments due to exchange rate movements, reduced imports, and moderate economic growth. Nevertheless, the government succeeded in reducing the budget deficit to 6.4 per cent of GDP in 2012 from 6.9 per cent of GDP in 2011, further consolidating the achievements made in the recent past to lower the fiscal deficit. Current and capital expenditure of the government declined from 21.4 per cent of GDP in 2011 to 19.7 per cent of GDP in 2012.
The debt to GDP ratio by end 2012 increased to 79.1 per cent, reversing the declining trend observed in the recent past, largely due to exchange rate movements. In nominal terms, the outstanding government debt increased notably by 16.9 per cent to Rs.6,000 billion at end 2012 from Rs.5,133 billion at end 2011. The total foreign currency denominated debt stock increased by Rs.207 billion (2.7 per cent of GDP) during 2012 due to the depreciation of the rupee against major foreign currencies.