The Sunday Times Economic Analysis

The Sunday Times Economic Analysis By the Economist

Are we sacrificing the peace dividend?
Whatever the merits and demerits of the constitutional and political crisis, there can be little doubt that its timing could not have been any worse. The constitutional propriety of the President's decision may be right, but it certainly was at the wrong time, in as far as the economy was concerned.

Just as when the country was tasting a part of the peace dividend and hoping that a durable and permanent settlement would bring a full peace dividend, the President's move to take over the defence portfolio, put the peace process on hold. Some of the benefits that the people as a whole were looking forward to, have become at best, uncertain, at worst dashed to the ground. The moves on the political chessboard are certainly proving intriguing and exciting. But whoever wins the political chess game, the people of the country are the likely losers.

A quick resolution of the problem and a clear picture of the future are essential for the process of economic recovery to gain speed and momentum. The worst affected sectors of the economy are the expected foreign aid flows that may not be available for sometime or not at all. The uncertainty in the political environment and security situation would no doubt affect foreign aid disbursement as well as foreign investment. Even local investors are likely to postpone their decisions to invest. Tourism is likely to be adversely affected just at the time when peace was ushering in a sharp revival of tourism and policies were being implemented to facilitate tourism and increase the country's capacity to cope with a much larger number of tourists.

These favourable developments should not be interpreted as indicating that the economy was faring well before the political crisis. Although several economic indicators like the increase in foreign reserves, increased foreign investment flows, sharp increase in tourist arrivals and the unprecedented rise in the stock market indices, gave the impression of an economic boom, in reality it was only a modest economic recovery. Comparisons with the poor economic performance of last year buttressed the impression that the economy was faring well. In fact there were serious fundamental weaknesses in the economy and the real economic performance was modest.

Let us look at these weaknesses. In the first eight months of this year the public debt continued to increase. It increased by over 5 per cent from Rs. 1669 billion at the end of last year to Rs 1767 billion at the end of August this year. The increase in public debt in the past 12 months was 5.9 per cent. This means that the public debt continues to be higher than the GDP. At the end of the year the public debt as a proportion of GDP is likely to be at the current level of 105 per cent of GDP.

The GDP grew by 5.5 per cent during the first and the second quarters, giving a 5.6 per cent growth for the first half of the year. However, this growth is not as impressive as it seems since the growth rates are from a low base. If the economy achieves the projected 5.5 per cent growth rate gives less than a 2 per cent average economic growth for the past three years (2000-2003). This is near stagnation of the Sri Lankan economy.

Though industry grew by 6.9 per cent in the first half of this year, this was in comparison with a decline of three per cent in the first half of last year. Indicative of the modest performance in industry is that industrial exports grew by only 12 per cent in the last 12 months, from August 2002 to 2003 of this year. This is inadequate as we are measuring the growth on the basis of a low performance of the previous twelve months. Industrial production increased by only 2.4 per cent in the last 12 months ending August 2003. Agricultural production declined in the first half of 2003. Agricultural export earnings declined by 1.3 per cent in the first 8 months. The notable increase in GDP was in services that grew by 7 per cent.

Although the recovery in industrial exports is significant, the industrial export growth of only 12 per cent is a cause for anxiety. This growth in industrial exports is less impressive when one realises that the industrial export earnings this year are lower than what we earned in the comparable period of 2000. By August 2003 the trade deficit for the year had reached US$ 876 million, higher than the deficit for the same period in 2002.

The extrapolation of the eight months trade deficit for the year means that the deficit is likely to reach around US$ 1300 million at the end of 2003. Such a large trade deficit indicates that the economic recovery has failed to correct fundamental weaknesses and raises questions on the export competitiveness of the country.

In spite of the fact that a more balanced assessment of the economy indicates a more modest economic gain than generally supposed, there was no doubt that the economy was poised to gain momentum. The political uncertainties are a definite setback to this.

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