AT A GLANCE
Sri Lanka is a Lower Middle-Income country with a GDP per capita of USD 4,073 (2017) and a total population of 21.4 million people.
Following 30 years of civil war that ended in 2009, Sri Lanka’s economy grew at an average 5.8 percent during the period of 2010-2017, reflecting a peace dividend and a determined policy thrust towards reconstruction and growth; although there were some signs of a slowdown in the last few years.
The economy is transitioning from a predominantly rural-based economy towards a more urbanized economy oriented around manufacturing and services. The country has made significant progress in its socio-economic and human development indicators.
Social indicators rank among the highest in South Asia and compare favorably with those in middle-income countries.
Economic growth has translated into shared prosperity with the national poverty headcount ratio declining from 15.3 percent in 2006/07 to 4.1 percent in 2016.
Extreme poverty is rare and concentrated in some geographical pockets; however, a relatively large share of the population subsists on slightly more than the extreme poverty line.
The country has comfortably surpassed most of the MDG targets set for 2015 and was ranked 73rd in the Human Development Index in 2015
RECENT ECONOMIC DEVELOPMENTS
The country-wide drought conditions continue to take a toll on macroeconomic performance.
The economy is estimated to have grown by 3.6 percent in the first half of 2018, following a 16-year low growth of 3.3 percent in 2017.
Agriculture and related industry sectors are expected to have recovered in the first half of 2018 with relatively benign weather. However, the ongoing episode of drought, which has been more pronounced from the beginning of the third quarter of 2018, has already impacted more than 900,000 people in 18 districts.
Increased agriculture output led to benign inflation in the first quarter of 2018. Favorable inflation outlook prompted the central bank to marginally relax policy rates in April, as the growth in monetary aggregates decelerated in response to a tight monetary policy.
However, subsequent currency depreciation and spill-over effects of increasing fuel prices increased inflation to 5.6 percent by August 2018. On the external front, exports rebounded thanks to the reinstatement of GSP+ preferential access to the European Union. Nevertheless, the gradually rising fuel bill and increased imports of vehicles and gold widened the trade deficit.
External liquidity received a boost from the proceeds of sovereign bonds and increased FDI compared to the previous year. While reserve cover of imports has improved from 2017, external vulnerability remains elevated with relatively high short-term liabilities. Amid tightening global financial conditions, the Sri Lankan Rupee depreciated by 5.6 percent against the USD by end-August 2018.
Albeit lower than expected, the government recorded a primary surplus for the first quarter of 2018; however, the higher than budgeted interest costs masked the 2017
The debt portfolio of the central government is subject to important risks with over 50 percent being denominated in foreign currencies, of which around 30 percent is expected to mature in the next five years.
While implementation of the cost-reflective fuel pricing will enhance fiscal sustainability, the flip side will be the need for targeted measures to protect the poor and vulnerable who may be affected more.
The gradual rebound of growth from last year’s record-low rate is expected to have helped improve the incomes of the poor. However, droughts continue to disrupt livelihoods and agricultural activities, and may have contributed to the recent notable drop in employment, especially among women in rural areas. In addition, inflation reached 6.5 percent in 2017, its highest levels since 2014, which likely offset some of the gains.
The outlook remains stable, conditional on reforms to improve competitiveness, governance and public financial management. Together with the IMF program, these reforms will add to confidence and lead to sustained growth and development.
Growth is projected to rebound in 2018 from a low base and continue to be marginally above 4.0 percent in the medium term, driven by private consumption and investment.
Inflation will hover around mid-single digit level, although currency depreciation and rising oil prices may exert some upward pressure. Despite global uncertainties, exports will benefit from spill-over effects of the reinstatement of GSP+, while tourism and remittances support the external balances. With improved hydropower generation, the growth in imports will normalize in the medium-term.
External reserves are expected to improve, thanks to debt inflows to the government, providing a buffer for debt redemptions. The Liability Management Act, passed in early 2018, will provide the flexibility for managing some important risks of the debt portfolio. The overall fiscal deficit is projected to fall in the medium term, supported by the implementation of revenue measures.
RISKS AND CHALLENGES
A further slowdown in reform implementation, in a challenging political environment, remains the key domestic risk to the baseline. Impending election cycle exacerbates this risk.
External risks include steeper than expected global financial conditions that would increase the cost of debt and make rolling over the maturing Eurobonds from 2019 more difficult; disappointing growth in key countries that generate foreign exchange inflows to Sri Lanka through exports, tourism, remittances, FDI, and other financing flows; faster than expected rises in commodity prices that would increase pressure on the balance of payments; and capital outflows that would further increase currency pressure.
On the fiscal and debt management front, risks include the delay in implementing revenue measures, and slower than expected improvement in tax administration. The increasing occurrence and impact of natural disasters could have an adverse impact on growth, the fiscal budget, the external sector and poverty reduction.
Sri Lanka needs to address several challenges that increasingly put its economic growth and stability at risk, through macroeconomic and structural reforms: (1) continue fiscal consolidation by broadening the tax base and aligning spending with priorities: this is important given high public debt, contingent liabilities and large gross financing needs; (2) shift towards a private investment-tradable sector-led growth model by improving trade, investment, innovation and the business environment; (3) improve governance and accountability and improve SOE performance; and (4) reduce vulnerability and risks by enhancing disaster preparedness and mitigating the impact of reforms on the poor and vulnerable with well-targeted spending.
The government recently announced plans to expand coverage of the main social protection program (Samurdhi), but details remain unclear.
Last Updated: Oct 17, 2018