With an economy of $16.6 billion, and a per capita GDP of about $872, Sri Lanka has mostly enjoyed strong growth rates in recent years. Sri Lanka began to shift away from a socialist orientation in 1977.
Since then, the government has been deregulating, privatising, and opening the economy to international competition.
Overall average annual GDP growth was 5.2% over 1991-2000. In 2001, however, GDP growth was negative 1.4%--the first contraction since independence. The economy was hit by a series of global and domestic economic problems and affected by terrorist attacks in Sri Lanka and the United States.
The crises exposed the fundamental policy failures and structural imbalances in the economy and the need for bold reforms. The year ended in parliamentary elections in December, which saw the election of a more pro-business government.
In 2002, Sri Lanka commenced a gradual recovery. Early signs of a peace dividend were visible throughout the economy--Sri Lanka has been able to reduce defence expenditures and begin to focus on getting its large, public sector debt under control.
In addition, the economy has benefited from lower interest rates, a recovery in domestic demand, increased tourist arrivals, a revival of the stock exchange, and increased foreign direct investment (FDI).
In 2002, economic growth bounced up to 4%, helped by strong service sector growth. Agriculture staged a partial recovery. Industrial sector growth, however, faltered for the second consecutive year due to weak demand and lower prices for Sri Lanka's exports. The government was able to exert fiscal control, and inflation trended down.
Total FDI inflows during 2002 were about $246 million and are expected to exceed $300 million in 2003. The largest share of FDI has been in the services sector. Good progress was made under the Stand By Arrangement, which was resumed by the International Monetary Fund (IMF).
These measures, together with peaceful conditions in the country, have helped restore investor confidence and created conditions for the government to embark on extensive economic and fiscal reforms and seek donor support for a poverty reduction and growth strategy.
Foreign exchange reserves, which fell by 11% in 1999, decreased further in 2000. In response, the government floated the rupee on January 23, 2001. This led to a significant nominal depreciation in 2001, but the rupee has since stabilised and reserves have gradually been replenished.
The year 2003 is poised to be another eventful year for Sri Lanka. Continued peace has allowed further progress on macroeconomic stabilisation during the first half of the year. Economic growth has picked up to 5.5% in the first quarter, from 0.5% in the comparable period in 2002.
This growth was largely driven by the services sector (particularly telecom and tourism), and the industrial sector posted modest growth. Both exports and imports have risen 13% in the first 4 months. Interest rates are declining. The inflation rate hovers around 9%.
External reserves were sufficient to cover 5.1 months of imports. The Colombo Stock Exchange has rebounded to become one of the better performers in the area.
The CSE rose 45% in 2002 and hit a record high in June 2003 as business confidence continued to expand. Fortunately, the SARS epidemic did not spread to Sri Lanka, and tourism was not severely affected.
Sri Lanka's garment exporters reported a surge in orders, shifted from China due to SARS. On the negative side, in mid-2003 Sri Lanka experienced its worst floods in 50 years, which caused extensive damage in south and south-western parts of the country.
The government is relying on donor funding to reconstruct the flood-damaged areas, avoiding recourse to government finances. The adverse impact from floods on overall growth for 2003 is estimated to be marginal.
Economic recovery is expected to consolidate during the rest of 2003, and GDP growth for the year is predicted at 5.5%, increasing to 6.5% in 2004. All major sectors of the economy are expected to expand.
This growth will, however, depend on the continuation of the peace process, policy adjustments (particularly budgetary control), and structural reforms. Recovery in the global economy also is important as well as effective aid utilisation.
The future of Sri Lanka's economic health is uncertain but largely dependent on the continuation of the peace process, political stability, and continued policy reforms--particularly in the area of fiscal discipline and direct management. Implementation of major reforms in the civil service and education sectors and more disciplined spending and improved revenue collection would help generate stronger economic growth.
If privatisation continues and export orientation strengthens, weaknesses in government will have less impact on growth. Real growth is expected to continue in the 4%-6% range beyond 2003 but may remain below the 8%-9% growth needed to move quickly into the status of a middle-income or newly developed country.
Other challenges include diversification from Sri Lanka's key exports--tea and garments. Garment exports will face increased competition in a quota-free era when the Multi Fiber Arrangement expires in 2005.
The future of the tea industry is threatened by a shortage of plantation labour and growing competition. There are new efforts to diversify exports, explore tourism potential, and improve competitiveness.
The government has an ambitious information and communications technology strategy to connect and service every corner of the country. This project, if implemented successfully, could change Sri Lanka's economy and social fabric and would take it into the information age.
The government hopes to take advantage of Sri Lanka's strategic location on shipping routes, make use of the Indo-Lanka Free Trade Agreement, and sign free trade agreements with other countries to achieve regional trading hub status. If peace returns and all these efforts bear fruit, real growth could be in the 6%-7% range beyond 2004, and will help realise the government's intention of making Sri Lanka the gateway to South Asia.
The service sector is the largest component of GDP (54%). In 2003, the service sector continued its strong expansion, fuelled primarily by strong growth in telecom and financial services. Public administration and defence expenditures have remained steady. Repatriated earnings of Sri Lankans working abroad continued to be strong.
Tourism continues to be a significant contributor to this sector as well, although it has not reached full potential due to continued worries about the conflict.
There also is a small but growing information technology sector, especially information technology training and software development and exports.
Manufacturing accounts for about 15.9% of GDP.
The textile, apparel, and leather products sector is the largest, accounting for 44% of total industrial output. The second largest industrial sector, at 24% of total manufacturing output, is food, beverages, and tobacco (this sector grew by 4.6% in 2002).
The third-largest industrial sector is chemical, petroleum, rubber, and plastic products--16% of output, with 5.7% growth in 2002.
Agriculture has lost its relative importance to the Sri Lankan economy in recent decades. It accounts for 20.1% of GDP and provides employment to 33% of the working population. Rice, the staple cereal, is cultivated extensively. The plantation sector consists of tea, rubber, and coconut; in recent years, the tea crop has made significant contributions to export earnings and saw production increases of about 5% in 2002.
Tea prices have continued to decline due to record world tea output in recent years. The construction sector accounts for 7.4% of GDP and mining and quarrying 1.8%.
In recent years, the government has eliminated many price controls and quotas, reduced tariff levels, eliminated most foreign exchange controls, and sold more than 55 state-owned companies and 20 estate-holding companies.
Colombo boasts one of the most modern stock exchanges in the region, and the Sri Lankan Government offers a range of tax and other incentives to attract potential investors.
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