Columns - The Sunday Times Economic Analysis

The questions people ask: Is the economy moving?

By the Economist

Economists are confronted in many different places and asked to explain what is happening in the economy. The diverse and contrary views about the country’s economic performance are no doubt the underlying reason for this. One can hardly satisfy these intelligent appetites in those brief encounters. Meeting an old friend at the Press Institute the other day led to such an encounter on the economy: What’s happening? Are we getting anywhere? Is the peace alone adequate to grow faster? What about unemployment? What would be the effect of the GSP Plus withdrawal? What is happening to agriculture? Can we achieve the high economic targets that are being continuously bandied about?

These are no doubt questions that are uppermost in intelligent minds even though the political dramas hit the headlines and are the talk of the town. The brief answers I gave the veteran journalist may not have satisfied him fully, but the general thrust of my answers appeared to be in line with his own thinking that all’s not well in the economy.

More comprehensive answers to these questions are attempted here.
As the questions themselves implied, the end of the war by itself will not ensure sustained economic growth, especially the ambitious targets set by the government of 8 to 10 per cent GDP growth with a doubling of per capita income in the next six years.

Some of the fruits of the peace are however evident already. We are seeing some of the benefits of the peaceful conditions in the country, yet the current levels of investment are inadequate to generate sustained economic growth of above 8 per cent.

Tourist arrivals have increased and this trend of increased tourists is likely to continue. During the first half of this year nearly 300,000 tourists visited the country. The increase in tourist arrivals have been from many countries and regions: India,West Asia, Western Europe, East Asia, North America, Australasia, and Eastern Europe.

Tourist earnings this year are likely to reach around US$ 800 million. This is a bonus to the economy and will generate employment directly in the hotel industry and indirectly in related enterprises like the gem and jewellery trade, travel trade, food and beverages and arts and crafts. There is every likelihood that the flow of tourists would continue to increase. This is therefore a sector where the growth could be sustained, especially if global conditions improve and nothing untoward happens in the country. In fact the current tourist boom is likely to accelerate in the coming years.

The economy may achieve a 7 to 8 per cent growth this year owing to the resurgence of several sectors such as tourism, fisheries, agriculture, construction and sub-sectors like transport, crafts, gems and jewellery. Also achieving a 7 per cent growth on top of the low 3.5 per cent growth of last year is relatively easy. Maintaining this growth after the initial benefits of peace is a more demanding task.

A growth of 8 to 10 per cent requires a much higher investment, both domestic and foreign. This in turn requires a considerably higher domestic savings ratio than the current 18 per cent of GDP. Fiscal consolidation that brings down the fiscal deficit to at least about 7 per cent of GDP is essential. Otherwise there would be a distortion of public expenditure and inflationary pressures. Unfortunately the fiscal performance this year too is unsatisfactory with indications that the deficit would reach 9 to 10 per cent. Therefore far more resolute measures to curtail the deficit and build an economic environment conducive to investment are needed to place the economy on the planned higher growth trajectory.

Investments in economic infrastructure in recent years are indeed a development in the right direction. No doubt infrastructure has been a serious bottleneck to rapid economic growth. It is to the credit of the government that there has been significant development in infrastructure. The generation of power, the improvement and construction of roads and bridges, and the development of ports and highways are vital to a modern economy. Despite these investments, their return is not immediate or even short run. Time alone will tell whether some of the large investments such as on the Hambantota port and the 2nd airport in the south would bring a commensurate return on the investment. In any case the gestation period of such investment is long term.

The prospects in agriculture are however different to those of investment on infrastructure and the developments in tourism. There is an immediate gain from agriculture owing to the resurgence in agriculture in the North. However once the immediate gains from the resuscitation of agriculture in the North and East tapers off, the gains in subsequent years is not likely to be spectacular. Employment gains in agriculture too could peter out in the coming years. Nevertheless the immediate gains are significant. In order to sustain the growth in agriculture there is an urgent need to improve the extension system in the country that appears to have been made dysfunctional after the transfer of this responsibility to the provincial councils.

Coupled with this is the lack of adequate amounts of quality seed for farmers to grow high yielding crops that are not susceptible to pests and disease. While scientists have found rice varieties with yield levels of 13 metric tons per hectare, the average national yields hover around a third at only 4.5 metric tons per hectare or less. Storage and marketing arrangements too have to be improved. There is a need to improve agricultural research capacity to sustain agricultural productivity in the long run.

The poor performance in industrial exports is a serious concern. The slow recovery of western economies coupled with the withdrawal of GSP plus status in Europe are likely to thwart industrial export expansion. This is seen in the performance of industrial exports in the first five months of the year when industrial exports grew by a modest 6.5 per cent and in garment exports, the main export declined by 7.5 per cent in the first five months of this year. The industrial sector that now contributes 38 per cent to GDP appears to be losing its competitiveness in global markets. It is important to reverse this so as to ensure the growth of an important component of the economy. Economic growth cannot be sustained in a small country such as ours without competitive industrial exports.

With peace foreign investment was expected to grow significantly. The high growth rates can be achieved by only a more than doubling of foreign investment. The foreign funds that are coming in for rehabilitation and reconstruction of the war devastated regions will hardly add to growth. It is the foreign direct investments in industry that would propel the economy. Despite the expectations of high foreign investment soon after the war, foreign investment inflows have been slower than expected.

Higher economic growth cannot be achieved by peace alone. Fiscal consolidation and economic stabilization, a greater focus on the economy rather than partisan political issues, more effective implementation of economic policies, reduction of corruption in the state sector and international diplomacy in the economic interests of the country are some of the vital imperatives for economic growth. Sustained economic growth requires much higher savings and investment than the current levels.

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