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Asian Tribune is published by E-LANKA MEDIA(PVT)Ltd. Vol. 20 No. 113

A “a powerful president” and a weak UNP opposition is good for Sri Lanka’s future growth -- Asian Development Bank

By H. L. D. Mahindapala

Highlighting Sri Lanka’s “impressive 7.2% growth in 2006 (which) reflected continued strong performance of services of 7.7% and an unexpectedly high outturn in agriculture of 5.9%” the latest Asian Development Bank report, 'Outlook 2007', says that the weakening of the UNP, the right-wing opposition, as a result of crossovers to the Mahinda Rajapakse government augurs well for future economic growth.

'Outlook 2007' states categorically that “a powerful president whose first term will end in 2011, and who has now also succeeded in forging a parliamentary majority with crossovers of Members of Parliament from the typically more private sector-oriented United National Party… could potentially lay the foundation for strong economic growth.” ADB reports states that this shows “a marked departure from previous approaches”.

Weighing the socio-political impact of the crossovers from the UNP to the government the report adds: “This could make implementing legislative changes easier than before, and could also be the beginning of a "southern consensus," the lack of which has been partially blamed for the slow resolution of the ethnic conflict in the country.”

This cautiously optimistic report of ADB knocks the bottom out of the prophets of doom and gloom in the UNP who have been preaching that Sri Lankan economy is now nearing the end of world.

'Outlook 2007' presents a more optimistic scenario. It says: “Despite resurgence of the civil conflict, impact of the Asian tsunami, and doubling of oil prices since 2004, the economy grew at its fastest rate since 1978 last year. This strength was fueled by buoyant private activity and expansionary macroeconomic policies that have, though, accelerated inflation. Growth is forecast to moderate over the next 2 years, given the conflict, slow pace of structural reform, and need to cool the economy. Further out, if the fiscal consolidation and increased investment envisaged in the new 10-year development framework are achieved, growth is expected to pick up substantially.

Some of the other highlights of the report are:

* The country's civil conflict is undoubtedly the main long-term challenge to development, shaving off an estimated 2% of GDP growth each year. Civil conflicts of such complexity can take decades, if not generations, to resolve. However, despite the opportunity costs of the conflict, the economy has grown at an annual average of 4.6% since the conflict started in 1983, and is a testimony to its resilience.

* Garments, which dominate the export and industrial base (contributing about 40% of export earnings), continued to struggle following the end of the quota system on 1 January 2005, growing by little more than 5% in 2006.

* Tourism fell due to blanket travel warning in European countries

* Construction continued to grow, in part because of tsunami reconstruction, but also because of major housing developments in big cities, bolstered by a surge in property prices and demand for high-quality housing by Sri Lankan expatriates, and by returnees to the country.

* The 2006 budget deficit was 8.9% of GDP, essentially unchanged from the 2005 outturn and in line with official budget projections. Three elements contained the deficit: the Government lifted revenue collection substantially for the second year running (up 27.5%); it removed almost all fuel subsidies that had cost it SLRs26 billion, or about 1% of GDP, in 2005; and it offset an SLRs38 billion cost overrun on recurrent spending by means of reallocating funds previously earmarked for capital expenditures. The bulk of the revenue improvement stemmed from changes to income tax (raised tax rates and lowered taxable thresholds), improved value-added tax (VAT) collection, and increased import tariffs.

* While public debt rose in 2006 in absolute terms, it declined as a proportion of GDP because of the rapid expansion of nominal GDP, but it still remained quite high at about 92%.

* The balance of payments has weathered the oil price shock relatively well, even as the oil import bill almost tripled in only 2 years to $2 billion in 2006. Nevertheless, strains are apparent, with the trade deficit remaining in double digits for the third year in a row, reaching 13% of GDP, a deficit not seen since 1994. The current account deficit stabilized at 2.8% of GDP, substantially lower than projected in the Government's medium-term economic framework.

* A major factor keeping the current account deficit largely in check and helping ease pressure on the balance of payments has been soaring workers' remittances, unexpectedly increasing by $400 million (or over 1% of GDP) to $2.3 billion in 2006: after the tsunami, they jumped by almost 30% a year (against 9% annual growth in the 5 years preceding the disaster).

* Even though foreign exchange reserves have been maintained at approximately $2.5 billion last year's 15.7% expansion in imports reduced the import cover ratio to 2.6 months by year-end from 2.9 months at end-2005. To safeguard reserves, the central bank imposed restrictions in late September 2006 on current payments, imposing deposit requirements of 50% on the import value of certain goods. The International Monetary Fund subsequently approved these restrictions as a temporary measure.

* The outlook for 2007-2008 is for growth of 6.1% and 6.0%, respectively, which is somewhat below government forecasts. It assumes that tighter fiscal and monetary policies gradually curtail aggregate demand by 2008, and that the conflict will continue to curtail tourism growth.

* The first steps taken in January 2007 to rein in growth of monetary aggregates suggest that the central bank is determined to fight inflation more aggressively than last year. Its financial and monetary policy plans of January 2007 indicate its intention to reduce growth of broad money supply to 13.2% by December 2007 (relative to estimated actual levels of 12 months earlier), a sharp drop from the 17.8% growth seen in 2006.

* The current account deficit in 2007 will narrow slightly to $764 million (or 2.5% of GDP;) due to substantially lower import growth following a projected stabilization of oil prices at about $57 a barrel. Export performance will stay muted, despite several expected positive developments for the garment sector. Concessional financing, tsunami-related grants (largely phased out by 2008), and commercial borrowing appear sufficient to finance this deficit. However, should oil prices be as high on average as in 2006 (about $65 per barrel), the current account deficit would increase sharply by 1.2% of GDP ($320 million) to 3.7% of GDP.

* In the long term, the significantly higher public investment planned by the Government will increase economic growth. Three major investment projects, some in the pipeline for 20 years, are now finally going ahead: the Kerawalapitya Combined Cycle Power Plant ($310 million), the Norrachchalai coal power plant ($510 million), and the extension and development of the Colombo Port ($300 million, with total project costs including planned private sector investment for the terminals eventually estimated at $1.2 billion). These investments are crucial to safeguard economic growth, act as a catalyst to private sector investment, and expand the country's role as a logistics hub.

* The current policy focus of the Government is on infrastructure development to improve electricity supply and roads. This is crucially important, but would need to go hand in hand with preparing the ground for higher productivity gains. To achieve this-and at the same time increase income equality-Sri Lanka needs a well-educated labor force and better access by the underprivileged to high-quality education.

- Asian Tribune -

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