Columns - The Sunday Times Economic Analysis

The economic recovery and growth in 2010

By Nimal Sanderatne

The Central Bank describes the economic performance of last year as “impressive”. The economy grew by 8.0 per cent according to its Annual Report for 2010. Last year could be characterized as a year of economic recovery and growth. It recovered from the setback suffered in the previous year when the economy reached rock bottom with an economic growth of only 3.5 per cent.

Foreign exchange reserves were so low that there were fears of an inability to pay for import needs. The Central Bank describes the recovery of last year as one that moved the economy “to a high and sustainable growth path”. It ascribes this growth momentum to “the peaceful domestic environment, improved investor confidence, favourable macroeconomic conditions and gradual recovery of the global economy from one of the deepest recessions in history.”

The economic growth of 8 per cent was achieved by growth in all three sectors: agriculture, industry and services, with most sub sectors of the economy growing. The structure of the Sri Lankan economy has changed since the liberalization of the economy in 1977 and the services sector now contributes the largest share to GDP of nearly 60 per cent while agriculture including livestock, forestry and fisheries contribute only about 12 per cent to GDP. Industry, including construction contributes about 28 per cent of GDP. Therefore agricultural growth though important contributes much less than the other sectors.

Agricultural growth

Agriculture grew by 7.0 per cent, compared to 3.2 per cent in 2009. This much improved performance was made possible due to several favourable factors. Paddy production increased significantly in 2010 due to the increased extent of cultivation particularly in the Northern and Eastern provinces and favourable weather conditions.

There was increased production of tea, rubber and minor export crops such as cloves, pepper and cinnamon. Fish production increased by 12 per cent owing to the expansion in fisheries activities in the Northern and Eastern provinces. Tea production reached the highest ever annual production of 329 million kg. Rubber production too flourished.

Increases in the production of other crops too contributed to the improved performance in agriculture last year. While the increase in milk production was noteworthy, coconut production declined by as much as 19 per cent and sugar production declined marginally.

Industrial production

The Industrial sector grew by 8.4 per cent. Improved performance in industries, such as food and beverages, rubber based products, textiles and garments coupled with increased performance in the construction and hydropower generation contributed to this growth.

The share of Industry in GDP increased marginally to 28.7 per cent with factory industry growing by 7.5 per cent and accounting to approximately 54.6 per cent of industrial output during 2010. It is noteworthy that garments and leather products that were adversely affected by the global economic crisis, showed signs of recovery during the last quarter of the year, despite the withdrawal of GSP+ concessions in August 2010. The apparel industry remained competitive through increased productivity, improved quality, diversification and gradual recovery in external demand.

The high growth in food, beverages and tobacco products category, which accounts for nearly 48.0 per cent of the total factory industry output, was driven by the expansion in domestic demand particularly from the Northern and Eastern provinces and increased tourism during the year. The major contributors to the increased output in export market oriented industries were ship building and repairing and transport equipment and machinery. The non metallic mineral products category also performed well due to the high demand for cement and building materials.

Growth in services

The services sector grew by 8.0 per cent in 2010. The wholesale and retail sub sector, which accounts for the largest share in the services sector, grew by 7.5 per cent with increased external and domestic trade with the recovery of the global economy and peaceful conditions in the country. Domestic and foreign tourism gave a boost to hotels and restaurants that grew by about 40 per cent. Transport and communications, banking, insurance and real estate also recorded significantly higher growth rates compared to 2009.

Fiscal consolidation

One of the significant improvements for achieving sustained high economic growth was the progress in the overall fiscal situation in 2010 that was reduced to 7.9 per cent of GDP in 2010 from 9.9 per cent in the previous year. Improvement in government revenue and the containment of recurrent expenditure enabled the reduction of the deficit. The improved fiscal outturn was facilitated by the expansion of economic activity and reforms in the tax system. If the government’s objective of reducing the fiscal deficit to 6.8 per cent in 2011 is achieved and further reduced in 2012 then the economic fundamentals could be improved. This would achieve economic and price stability and develop an economic environment conducive to sustained high economic growth.

Trade and Balance of Payments

The Central Bank’s assessment of external trade is that it was a favourable performance. This is because “both exports and imports recovered strongly, while increased earnings from the tourism industry and higher inward remittances offset the widening trade deficit to a great extent, reducing the external current account deficit. Increased capital and financial flows resulted in the balance of payments (BOP) recording a surplus in 2010, further strengthening external reserves of the country.” The Central Bank reports that “external trade rebounded strongly in 2010, reversing the sharp contraction observed during the global recession of 2009.”

Export earnings increased by 17.3 per cent, owing to higher earnings from industrial and agricultural exports. However expenditure on imports grew by nearly twice that of exports by 32.8 per cent and consequently the trade deficit expanded to US$ 5.2 billion in 2010. Agricultural exports continued to fetch high prices but higher commodity prices, particularly crude oil prices, increased import expenditure considerably. Imports of consumer durables, such as motor vehicles and electronic goods also increased following the tariff reductions and imports of investment goods such as imports of machinery and transport equipment also increased in 2010.

The huge trade deficit of US$ 5.2 billion was offset by higher inflows of capital and resulted in a surplus in the overall balance of the payments. The external reserves improved to its highest level by end 2010 when they reached US $ 6.6 million compared to US $ 5.5 billion at the end of 2009. Although the balance of payments recorded a surplus of US dollars 921 million in 2010, it was significantly lower than the surplus of US $ 2,725 million in 2009.

The most disconcerting fact is that the country suffered the worst trade deficit in history, of US$ 5.2 billion. By downplaying this the Central Bank is covering up the serious trade imbalance that is threatening to grow this year with further increases in import expenditure. If current conditions prevail the trade deficit may reach a mammoth US$ 8 billion or more and capital inflows may be inadequate to generate a balance of payments surplus.

Summing up

The economic recovery of 2010 was expected after the restoration of peaceful conditions from mid 2009. Much of the growth was related to the improvements in security conditions, renewed investor confidence, expansion of economic activities, reconstruction, foreign borrowing, revival of tourism and development of infrastructure. The recovery of global economic conditions too assisted the export sector. The reduction of the fiscal deficit, increase in the domestic savings from 17.9 per cent of GDP to 18.7 per cent and national savings to 24.7 per cent and the decrease in government consumption from a high level of 17.6 per cent to 15.6 per cent in 2010 are significant improvements. Private investment increased from 17.9 per cent in 2009 to 21.6 per cent in 2010, while public investment declined marginally from 6.6 per cent of GDP in 2009 to 6.2 per cent in 2010. Total investment increased to 27.8 per cent of GDP in 2010. These are positive features hat lend hope to the expectation of a high sustained trajectory of growth.

The disconcerting developments are the large trade deficit, massive public debt and foreign debt and their servicing costs. The huge trade deficit that may widen further this year are serious concerns that must be addressed. Although inflation was kept to single digit proportions, the latter part of the year witnessed increasing inflationary pressures. These concerns must be addressed if the growth momentum is to be sustained on a high trajectory of economic growth.

The increasing crude oil prices and the impact of slower global recovery in the aftermath of the Japanese earthquake and tsunami, the possible decrease in demand for tea and labour in the Middle East are external anxieties that the economy would have to cope with.

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