Raising the bar: The rise of the Sri Lankan economy

The Central Bank of Sri Lanka recently unveiled its pioneering Sixth Strategic Plan – communicating in all transparency its plans for the forthcoming financial period – based on the theme ‘Raising the Bar’.

The Sixth Strategic Plan, like its predecessors, takes root from the policy measures underscored in the ‘Mahinda Chinthana,’ and is formulated to maintain economic and price stability, as well as financial system stability, and to contribute to the overall economic prosperity and sustainability of the country.
Since 2006, the Central Bank of Sri Lanka has endeavoured to fulfil its core objectives, making necessary interventions and successfully building on structural changes that were taking place in the local economy. Thus, the Sixth Strategic Plan is not simply a pipe dream; it is the blue print for a prosperous future, based on fundamental financial and economic criteria in our growing domestic economy.
At a time when First-World Europe is bracing itself to face widespread economic calamity, Sri Lanka is confident of major growth contributions from its Agriculture, Industry and Services sectors, the sustenance of a high growth rate of 8%, a significant fiscal deficit decline and the delivery of a mid single digit inflation rate in 2012. The credible success stories of the past year have only cemented the fact that the trajectory of the Sri Lankan economy is moving upwards.

Accelerated growth
Reputed analysts have pointed out that the growth of the Sri Lankan economy has accelerated in 2011, with increased investments and the strategic avoidance of the interest rate increase that plagued the rest of Asia. Our stable inflation rate assisted in expansion efforts and brought stability to the region.
With strong macroeconomic conditions, surging Gross Domestic Production rates and appropriate and timely monetary policies in place, the IMF too has recognised the potential of our peaceful prosperity, especially when disbursing loans.
Since the end of war in 2009, Foreign Direct Investment mounted to over $ 413 million at the beginning of 2011, with projections indicating that $ 1 billion was largely met during the course of the year. It is indeed remarkable that for the first time in the history of Sri Lanka FDIs exceeded $ 1,000 million and the fourth international sovereign bond, issued in July 2011, was oversubscribed by 7.5 times.
Local companies like Sri Lanka Telecom PLC also invested over $ 100 million to expand networks within the country, primarily in the north and east. President Mahinda Rajapaksa pledged to invest $ 1 billion annually for at least three years (from 2010) on projects that generate jobs and support our growing economy. Such projects include power plants, highways, expressways and container shipping terminals, and are scheduled to take off in areas outside of the Western Province in order to equally distribute infrastructural development around the country.
Foreign exchange inflows for 2012 are also calculated to be soaring at over $ 25 billion. Such streamlined and widespread capital investment, private sector collaborations and foreign direct investments of significant proportions magnitude, coupled with the overall strengthening of the local economy, will only augur well for the country in the coming years, especially when competing with the sluggish world economy and volatile emerging markets.

GDP growth
The real GDP growth in 2011 was estimated at 8.3% – the first time in history when our economy recorded over 8% growth in two consecutive years – while GDP per capita was estimated to reach $2,830 and is calculated to increase to $ 4,000 by 2016.
The Services sector was estimated to have grown by 8.6%, with a contribution of $ 34 billion to the overall GDP of $ 59 billion, while the Industry sector’s growth was estimated at 10.1% with a contribution of $ 18 billion to GDP. Even the hard-hit Agriculture sector recorded an estimated growth of 2% with a contribution of $ 7 billion to GDP.
The IMF, which has in place a standby loan facility in the country, has also pointed to the ‘strong growth in the country’ and its consistent fiscal performance. Given the fact that the IMF sharply revised its growth forecast for the USA to a meagre 1.6% in 2011, while lowering its financial outlook to 2% for 2012, the Sri Lankan Government can remain confident of implementing the correct policies to secure strong domestic growth and achieve a $ 100 billion economy by 2016, with a stock market valued at 70% of the GDP. While the IMF predicted that the world economy grew at a lethargic pace of 4% in 2011, while emerging and developing economies achieved a growth rate of 6.4%, Sri Lanka’s GDP has indeed raised the bar globally.

Euro Zone collapse
The Euro Zone collapse has witnessed staggering debt to GDP ratios, which have undermined national economies and destroyed investor confidence. In Greece, the debt to GDP ratio soared to 165%. Italy recorded a ratio of 121%, when the maximum tabulated debt in the Euro Zone is limited to 60% of the GDP. Even the USA recorded a shocking 100% debt to GDP ratio recently and facing severe spending cuts as re-election drawn near for Obama-led Democratic Government. In Sri Lanka however, the debt to GDP ratio was estimated to fall at 78.2% in 2011, a significant decrease since 2006, when the ratio was at 87.9%. The risk indicators of Sri Lankan public debt improved, irrespective of rising global risks and public debt management recorded many improvements which enabled the cost of debt to be brought down, with the overall average interest rate of Treasury Bills and Bonds declining by about 101 and 81 points respectively.
Germany, which is being hailed as the strongest engine of in the European markets and the driving force behind many bailout packages, has a ballooning debt of 83.2% of its GDP, while Japan’s ratio is up by 230% – worse than any failing European State. In addition, the IMF debt forecast paints a doomed picture for G-20 countries, whose debt projection stands at 84.6% in 2014, while for Advanced G-20 countries it sky-rockets to 114.1% during the same year.
The Central Bank of Sri Lanka remains positive in its public debt managements skills, with a further improved debt to GDP ratio of 60% projected for 2016. The Central Bank hopes to further enhance our sovereign credit rating, maintain a sound regulatory framework, broaden investor base, enhance secondary market trading of Government securities and meet borrowing targets at lowest costs with a prudent degree of risk. Our debt to GDP ratio for 2012 is estimated to be a very achievable 75%.

Inflation
In 2011, Sri Lanka also boasted of a mid-single digit level inflation rate. This is no ordinary feat by any means, given the rising costs of primary inputs, especially oil. Year-on-year inflation declined to 4.9% in December 2011 from 6.8% at the end of December 2010, while year-on-year core inflation for December 2011 was 4.7% only.
In 2012, the Central Bank expects to deliver average inflation rates, continuing with mid-single digit level figures. Consumer price inflation based on CCPI is expected to be maintained between 5%-6% in 2012, while a decrease in inflation – as measured by the GDP deflator – is estimated to be around 6.5% in 2012.
Even with external pressures, like the sovereign debt crisis in Europe, the inflation rate in Sri Lanka continues to remain stable. Our closest and economically powerful neighbour India posted a record increase in its wholesale price index in 2011. In October 2011, the index rose to 9.73% despite slight falls in global fuel and commodity costs. The Indian Central Bank has increased its rates more than 13 times since March 2010 to combat rising prices. Fuel price inflation stood at 14. 79% and food price inflation was marked as 11.06%. These prices have been driven by the fall of the Indian Rupee, which was at its lowest level against the US Dollar for over two years in 2011.

Fiscal consolidation
Another feather in the cap of the Government is its successful fiscal consolidation efforts. Sri Lanka’s fiscal deficit was estimated to be below 7% of the GDP in 2011, down from 8% in 2010 mainly due to a tight control on expenditure and spending policies. Such a consolidation effort comes at a stage even while public investment was maintained at 6% of GDP in 2011.
In 2012 the Central Bank expects the fiscal deficit to decline further to a significant 6.2% of the GDP, with domestic financing increasing and the reduction in net credit granted by the banking system to the Government favourably impacting on both the availability of funds to the private sector and as well as domestic interest rates.
Our actions come at a time when the world’s last remaining super power, the USA, is reeling after posting its third consecutive annual budget deficit in excess of $ 1 trillion in the fiscal year ending on 30 September 2011.

Sovereign rating
Sri Lanka’s sovereign rating vastly improved in 2011, with three international sovereign rating advisers – Bank of America Merrill Lynch, HSBC and Royal Bank of Scotland – assisting in enhancing our efforts.
Standard and Poor’s upgraded Sri Lanka’s rating to B+ (positive), while Moody’s rated the country as B1 (positive). The country was further rated as BB- (stable) by Fitch Ratings in 2011, thereby evidencing the upward trajectory of the nation’s sovereign rating.
This profiling is in stark contrast to many advanced economies around the world, which have been downgraded from their superior sovereign ratings. Most recently, France was downgraded a notch by Standard and Poor’s to AA+, thereby losing its top AAA rating. Further imploding the EU economic crisis was the fact that the Agency also cut Italy, Spain, Cyprus and Portugal’s ratings by two notches. Austria, Slovakia, Malta and Slovenia were also downgraded and out of all the Euro Zone States, only Finland, Luxemburg, Germany and Netherlands managed to retain triple A ratings.

Unemployment and productivity
Another key feature of the Government’s efforts in 2011 was the decline of unemployment and the increase in labour productivity. The unemployment rate declined to 4.3% during the first half of 2011, due to the reconstruction, infrastructural development and expansion of economic activities. There was also an increase in the share of employment in the micro entrepreneurship category, along with a sharp drop in unemployment among the age group of 15-24 years.
This is a laudable achievement, considering that the entire world is reeling because of the effects of staggering unemployment rates. Spain is plagued with a colossal unemployment rate of 20.7%, while France’s rate stands at 9.5%. The USA’s unemployment rate is 9.1%, while the United Kingdom is combating a high unemployment rate of 7.8%. The liberalisation of exchange control regulations also helped spur growth in 2011 and positive measures were taken to prevent informal and illegal schemes which may have led to a foreign currency leakage of over $ 1.5 billion. The Sri Lankan foreign exchange rate remained stable through 2011, encouraging the inflow of FDI and funding through sovereign bonds. However, the fear is that when most regional currencies, like the Indian Rupee, are depreciating gradually, our opportunities for trade and economic relations are affected negatively by a strong currency.

 Rupee devaluation
Despite the many pioneering efforts undertaken by the Government of Sri Lanka to boost the economy in 2011, certain measures were labelled as unnecessary or detrimental to the overall growth of the markets. The recent decision of the Central Bank to sell US Dollars from its foreign exchange reserves in order to defend the Sri Lankan Rupee after it was devalued by 3% in November 2011, was criticised by many, with even Finance Ministry Secretary Dr. P.B. Jayasundera acknowledging that the exchange rate should be only driven by market forces unless in cases of volatility. The surprise devaluation by the Government of the Rupee to 113.90 from 110.40 shocked the currency markets and the bond markets are still adjusting to this change. This is a matter of monetary policy making, which is outside the purview of the Treasury. Such an interventionist approach from the Treasury will only cause a negative impact on market trends, damaging investor confidence. Dr. Jayasundera however, further stated that in order to ‘ease the ballooning trade gap’, such a ‘market correction’ was essential.
This devaluation of the Rupee currency was initially viewed by the IMF as a positive step which would support the country’s export competitiveness and safeguard its reserves over the medium term. However more recently the IMF has begun exerting pressure to stop managing the Rupee, warning that continuing intervention was threatening the ‘non-borrowed foreign exchange reserve position’, and withheld its eighth tranche of a $ 2.6 billion loan as a result.
The Central Bank has already spent more than $ 850 million propping up the Sri Lankan Rupee and foreign exchange reserves fell around 27% in the last five months of 2011 to $ 6 billion, while most Asian countries allowed natural market conditions to take over, resulting in the fall of their currencies. The Governor of the Central Bank Ajith Nivard Cabraal gives new confidence by stating that US Dollar inflows in the immediate future will ‘soften depreciation pressure’ on the Rupee. “We see a large inflow coming in,” Cabraal said. “Ours is a measured intervention, which is going to be on both sides.”

Export growth
Another worrying factor remains that Sri Lanka’s export growth is below that of countries like India. Our import growth, which stands at 50.7% during the first part of 2011, far outweighs our export performance. With the increasing current account deficit in the balance-of-payments, where imports almost double that of exports, there will be considerable pressure on the exchange rate to depreciate.  The 3% devaluation of the Rupee has also proved to be ineffective in easing import pressure. Predictions that exports will take a dip in 2012, due the economic slowdown in Sri Lanka’s major markets such as the US and the EU (accounting for 56% of the all exports), also negatively impact the Sri Lankan economy.
Thus, one needs to carefully assess the actual growth in 2012, which should still manage to remain within the 7-8% growth bandwidth. One can safely predict that the trend in the balance-of-payments experienced in 2011 will continue in 2012, as the trade deficit continues to expand on higher import demand. One cannot avoid such demands, which have arisen due to the post-war infrastructural development which is taking place. The balance-of-payments will apply pressure on the exchange rate as well as the interest rate, so it is heartening to be assured by the Governor of the Central Bank that foreign fund inflows are expected soon, which will help mitigate the negative effects of our widening trade deficit.

Successful strategies
Despite these minor hiccups, one needs to applaud, encourage and stimulate the policy makers of our country for the immensely successful monetary plans and fiscal strategies adopted, which have assisted in completely transforming the local economy since 2006. Although 2011 was a challenging year, with deeply catastrophic global economic trends emerging, the Sri Lankan economy survived and soared! We not only stood out as a testimony of growth and development in a post-war era, but also as a courageous nation, willing to overhaul challenges and successfully implement policies that are home grown and resilient to volatile global manoeuvrings.  The motivation of our fellow countrymen is a necessity to realise the ambitious economic goals set for the country, so that we can all directly participate in and contribute towards the enhanced sustainable development of the economy. A time like this calls for the complete harmonisation of economic, financial and business elements and sectors in the country… a brand of economic patriotism built on the foundations of peace; a peremptory commitment towards sustainable growth, which transcends all formidable, divisive frontiers.
(The writer is a Chartered Accountant. He is the Managing Director/CEO of Chemanex PLC and a Director of CIC Holdings PLC and Commercial Bank PLC. He is also the Chairman of The Finance Company PLC and serves on the Boards of many other Public and Private Companies in Sri Lanka and abroad. He is a member of the Monetary Policy Consultative Committee of the Central Bank.)