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2010 Sri Lanka Economic Update

May 14, 2010

Sri Lanka’s Stability in a Weak Global Economy
During the second half of 2009, the economy expanded by 3.3%, the fastest rate ever recorded since 2002. Indicators, such as increased registration in new motor-vehicle registration and electricity generation, confirmed a strong increase in economic activity for the region. In addition, the agriculture, transportation, and communication sectors showed strong performance in the last quarter of 2009, with the hotel industry growing approximately 32% due to an influx of tourists after the end of the conflict.

Nevertheless, economic growth from the first half of 2009 thwarted the year’s overall growth potential. The delayed effect of the erosion of households’ purchasing power, and tighter credit markets, played a key role in making a less than impressive start to 2009.

Private Sector is key for Growth
In 2009, the government’s continuation of public employment (a staff increase of over 60,000) added approximately 3.7% to growth and aided in sustaining the country’s economy. However, the growth in employment of the public sector balanced the sharp decline in employment within the formal private sector, which lost approximately 170,000 jobs. The growth in the labor market remained tight, and supported only a modest increase in real wages. Real wages of the private sector only rose by 1.6% in 2009, following growth of 2.6% in 2008.

The fall in international commodity prices significantly improved the current account deficit by reducing it to 0.5% of GDP, in comparison to 2008’s deficit of 9.5%. The trade deficit will likely widen due to the recent rise in international food and energy prices will increase the cost of imports in addition to growing infrastructure investments.

Keeping an Eye on Inflation and appreciating Rupees
Through most of 2009, the main thrust of the Central Bank of Sri Lanka (CBSL)’s exchange-rate management was to prevent the rupee from appreciating. The intervention ensured a stable exchange rate of around Rs. 115 to $ during the second half of 2009 and in early 2010. Foreign financing flows have been robust since the conflict ended in May 2009. Therefore, recovery programs should be sustained to maintain capital inflows.

Inflation has gradually ticked upward since September 2009. Inflation fell rapidly to 0.7% in September 2009. However, the gradual uptick in inflation since September 2009 resulted in year-on-year inflation reaching 6.9% in February 2010 before moderating somewhat in March, to 6.3%. Inflation is expected to stay relatively low in 2010, due partly to increased agricultural production in the North, which will help contain food prices.

Tax Reforms
The government has committed to reform and streamlining the tax system and administration, which would yield higher revenues. The Presidential Tax Commission was initiated in the 2009 budget to review current tax policies and recommend measures to strengthen tax collection, auditing and enforcement, and a general simplification of the system.

Looking Ahead
Increases in foreign direct investment and tourism, along with improved employment and large-scale reconstruction projects in the North, are expected to sustain and accelerate Sri Lanka’s growth throughout 2010.