The general elections of 2004 brought about a change of government and a shift in economic policies. The UNP that had a majority in Parliament lost to the United People's Freedom Alliance (UPFA), an SLFP-led coalition that included the Janatha Vimukthi Peramuna (JVP) and the Jathika Hela Urumaya(JHU). This change of government was interpreted as a rejection of 'neoliberal economic policies' and the adoption of 'home grown' nationalistic policies. During the seven-year period from 2004 to 2011 there were several shifts in policies as well as changes in economic conditions.
The change of leadership in the 2005 Presidential election accentuated this change in economic policies. While President Mahinda Rajapaksa's economic policy retained the liberal economic framework, it made significant adaptations. The Mahinda Chintana programme gave greater emphasis to domestic agriculture and rural infrastructure development. It implemented several rural development programmes to uplift the livelihoods of rural people and increase domestic food production. Policy statements emphasised the need for pro-poor economic growth.
The new government turned towards a nationalistic orientation in its economic policy which was often described as one of building a strong national economy. This reorientation was given expression in the Mahinda Chintana. Basic differences in policies were an emphasis on the rural economy and on small and medium industry, more weight on poverty relief and equitable distribution of incomes between the urban and rural sectors. It espoused a policy of import substitution in food with a revival of small irrigation works especially in the dry zone. A fertilizer subsidy was introduced. An important departure in policies was the rejection of privatisation and greater state control of the economy. Trade policies veered towards import substitution and tariffs on many imported items were increased.
The government promoted a policy of greater degree of import substitution in food with a revival of small irrigation works in the dry zone. In pursuance of the government's policy of enhancing self-sufficiency in food and uplifting the livelihoods of rural conditions, the government embarked on a number of rural development projects. These included the Hadabima, Api Wavamu Rata Nagamu and Divi Neguma projects. The Hadabima -- cultivation of vegetables -- engaged armed forces released from fighting, while the Api Wavamu Rata Nagamu was aimed at making individual households produce some food items such as vegetables or fruits in their home gardens. This helped during the 2008/2009 global food prices when imported food prices rose sharply.
A more recent programme is the Divi Neguma programme. It is a national programme for establishing 1,000,000 household economic units, covering all the villages in the country, combining agriculture, fisheries and animal husbandry, as well as cottage industry. Its avowed objectives are to improve the nutrition level and reduce the cost of living of the families, while ensuring food security and creating additional incomes. In order to encourage production of food crops and increase milk and sugar production, the import duties on several food imports and milk and sugar have been increased. This policy is also partly to reduce import expenditure that has been increasing.
During 2001-04, just prior to this period, import policies became more restrictive, especially tariff protection of agriculture as part of government policy of import substitution. From late 2004 there was a deliberate move towards import-substitution and protectionism mainly in agriculture but also in manufacturing. This was a reversal of the liberal trade policies adopted since 1977. The political climate had become more conducive to protectionist policies and this protectionist trend continued and intensified during 2007-09. In June 2010, there was a relaxation of import duties, especially on cars and electronic items that led to a surge in imports. Once again higher tariffs were imposed on several commodities in 2011.
There has been a big push in development of economic infrastructure. Despite the economic difficulties due to the high war expenditure, the government placed an emphasis on infrastructure development. This programme of economic infrastructure development gained momentum after the ending of the war in 2009. Roads, bridges ports have been built and rural roads improved. Infrastructure development has been definitely beneficial in the power sector. In the post war years there has been much investment in the development of infrastructure in the North and East. Apart from roads and bridges, there has been housing construction to provide homes for the displaced. Poor infrastructure has been a bottle neck to development. Therefore, the current development of infrastructure would contribute to the efficiency of investment.
However, several questions have arisen. Are all the infrastructure investments on the basis of priorities? Are they cost effective? Have they been on a least cost basis? Are infrastructure projects creating balance of payments difficulties, on the one hand, and on the other hand, increasing foreign debt? In contrast, to the increase in investment on economic infrastructure, social infrastructure development has been quite inadequate. All levels of education are underfunded and public health expenditure too has not risen. The long term economic capacity may be weakened by inadequate development of human capital.
Government policies have veered towards greater state control of the economy. This policy of state control of important areas of economic activity has been achieved by three measures. First, by the takeover of previously privatized economic entities such as the Insurance Corporation, Sri Lankan Airlines and Shell gas. The second intervention by the state has been the state ownership of business enterprises, mainly banks, by government agencies by buying into them and taking control of governing boards. The third means was the enacting of legislation to take over so called underutilized and underperforming enterprises.
These three actions of the government have had detrimental effects on private investment. These measures have resulted in fears of government interference in the economy and taking over private businesses. It has raised questions as to whether the private sector has much of a role in the country's development. The role of the government in the economy is growing and the business community intimidated. The setback to business confidence owing to these state actions is severe and requires to be redressed by the government.
The government faced severe economic difficulties in 2004, its first year in power. The high balance of trade deficit strained the balance of payments and depleted foreign exchange reserves to reach a low level. The Tsunami of December 26, 2004 was a huge humanitarian disaster but the relief that poured into the country changed the external finances into a sustainable one. Despite this relief, the next few years were ones that took the country into a brink of economic disaster.
Global economic conditions on the one hand were not favourable to the country's exports, while the costly war was sapping the capacity of the country to invest adequately. Economic growth during the 2004-2009 period plummeted to less than 4 percent. The public debt and debt servicing costs increased. In 2008 90.5 percent of revenue went for debt servicing and by 2009 debt servicing costs exceed the annual revenue of the government: it was 117 percent of government revenue.
The economy moved towards a crisis in 2009 when balance of payments difficulties brought the country to the brink of foreign reserves. It was a period when war expenditure escalated and economic fundamentals weakened. In 2009 the economy reached a nadir with problems in its external finances, inadequate revenue to even service the public debt, continuing high fiscal deficits and economic activity depressed. It was at this point of time that the end of the war brought about fresh hope and prospects for economic recovery.
Post-war economic recovery
The end of the war in May 2009 was a turning point in the country's political history and economy. It marked a revival of the economy. The crisis in external finances that reached an unsustainable proportion was rescued by a standby credit facility of US$ 2.6 billion from the IMF. On the strength of this, the government was able to borrow in international commercial markets and increase reserves progressively to reach US$ 8 billion in August 2011. In the two years 2010 and 2011 the country achieved high economic growth rates of 8percent. However at the end of 2011 the large trade deficit of over US$ 10billion caused severe strains in the balance of payments and the net external reserves (non-borrowed amount) were once again low.
Despite the high economic growth rates, the economy has several fundamental weaknesses. The public debt and debt servicing costs are high, foreign debt is estimated at around US$ 25 billion, fiscal deficits have been brought down but further fiscal consolidation could be difficult. The ballooning trade deficit is a serious concern. Sustaining the current rate of economic growth and raising it to a still higher trajectory of growth would depend on attracting significant amounts of foreign direct investment. Therefore an investment climate that is attractive for foreign investors is vital for the country's economic development. Some of the current economic policies and the law and order situation are serious disincentives to foreign direct investment.