Columns - The Sunday Times Economic Analysis

The uphill task: Sustaining economic growth

By Nimal Sanderatne

The sustainability of economic growth is a serious challenge. The high growth of 8 per cent achieved in the past two years is unachievable this year. Unless appropriate policy measures and a growth strategy that ensures a lower trade deficit are in place, balance of payments constraints could jeopardise long-term economic growth. Equally important are reforms that ensure a climate conducive for private investment, both foreign and domestic; reduction of the fiscal deficit; containment of the public debt, especially its foreign debt component and prioritisation of investment.

The Central Bank estimates that this year's GDP would grow by 7.2 percent. Most analysts expect it to be less than 7 percent: perhaps about 6.5 percent. What is important is not the precise figure but that the strategy of economic development does not destabilise the economy and lead to an inability to sustain the growth momentum.

The irony is that the high growth rate achieved last year is itself one of the reasons attributed for the slowing down of the economy. Last year's economic growth itself contributed to the balance of payments crisis that resulted in a loss of reserves, depreciation of the currency and difficulties in maintaining economic growth. This raises questions on the nature and the character of economic development strategy in the country.

Asian Development Bank assessment

In its recent report, Asian Development Outlook 2012, the Asian Development Bank (ADB) expressed the view that "2012 will be a tough year for Sri Lanka" with the regime of policy uncertainty proving to be an obstacle to attracting much-needed investment, with the private sector performing below expectations. The ADB is of the view that "Despite the improved political and economic environment, growth in private investment-domestic and foreign-is falling below planned levels. One reason is that the government has taken only a few steps to reduce red tape and improve the business climate, needed to create the conditions for ramping up private investment".

The sustainability of economic growth depends on high rates of investment and the efficiency of capital. Investments would have to come from the private sector and from foreign direct investment. As the ADB has pointed out, "Investor confidence is a key factor in attracting investment and this requires a predictable policy environment as articulated and reinforced through the legal, regulatory, and institutional framework. Thus the lack of such an environment for the private sector is a major obstacle to private sector development. Developing that framework will reduce uncertainties in the business environment and avoid unplanned actions that may send mixed signals to potential investors."

This column and many economists have pointed out the need for continuity and certainty in econoomic policies. This is so as private investment requires such certainty and incentives to take risks in their investments. There are also much needed reforms in labour laws, law and order and a clear cut policy on the role of the private sector. Without these a spurt in economic growth cannot be maintained.

Slower growth

There is a consensus that the economy would grow at a slower pace, though at a reasonable high rate. The Central Bank itself estimates that the economy would grow by less than last year's 8.3 percent. The Bank expects this year's GDP to grow by 7.2 percent. The ADB expects Sri Lanka's economy to maintain its strong performance of the last two years but since growth prospects for 2012 are less favourable it expects the pace of growth to moderate to 7 percent. The ADB explains this as " due to slower growth in industrial countries and attendant weaker growth in global demand and trade, and partly due to domestic factors: the rebound has largely run its course and with little slack in production capacity signs of overheating have emerged that will require tighter demand-management policies to forestall the buildup of serious economic imbalances."

Economic growth in 2011

What everybody is asking is how come a high growth of 8.3 percent in 2011 led to a huge trade deficit? What were we producing? What were we consuming? The balance of payments crisis resulted in a loss of reserves, depreciation of the currency, higher import tariffs, increasing prices of fuel and electricity and the increasing of interest rates. The national interest is in what it has resulted in. These are the real concerns. These will bring hardships to especially lower income groups and affect growth as well. The instability of growth is a real concern. In fact it has been pointed out that the economy has achieved high rates of economic growth in the past as well, but these years have been followed by years of low growth. What need to be achieved are reasonably high rates of growth sustained over a period of time: not bursts of growth followed by busts.

This does not mean that there has not been economic growth in the post-war period. There has been fairly high growth owing to several sectors and regions increasing output. One of the important reasons for the higher growth is that the North and East did not contribute to economic growth before the end of the war. With the end of the war these regions revived and their output was included in the national estimates.

There were also several sectors in the economy that were badly affected by security conditions and the war. Fishing in particular was seriously restricted. Since the war fisheries production has increased significantly. Tourism is booming and having favourable backward linkages. There is improvement in infrastructure especially roads and bridges. However expenditure on infrastructure has to be contained owing to the high import costs incurred.

Balance of payments implications

There has to be adequate attention of the balance of payments implications of development projects. A small open economy so dependent on trade and with high propensities for imports must fashion its development strategy mindful of the balance of payments implications. If this is not done then the kind of problems we are facing today will recur. Increasing exports and reducing imports must be considered in the development strategy.

Although the Central Bank boasts of the growth of exports by 22 percent, the growth in imports is more than double that. It is important to enhance export earnings while curtailing import expenditure especially of petroleum, machinery and building materials. Petroleum imports constitute the most serious problem with its import expenditure being as much as 25 percent of import expenditure. Both the quantity of imports and international prices matter.

On the side of import quantities there are serious difficulties in containing imports as petroleum products are needed for essential needs such as transport, the generation of electricity and for industrial production. Despite this it is vital to devise means by which consumption is curtailed. Even a 10 percent reduction in the quantity imported would make a difference to import expenditure. It is also important to contain consumption as petrol prices in the international market are very volatile. As it is not possible to have any control on international prices, it is essential to rein in consumption.

Infrastructure development

The government's programme of infrastructure development was also an important contributory factor as the large expenditure on infrastructure development led to increased imports of construction materials and machinery. The returns on such infrastructure development are slow and their contribution towards increasing exports or reducing imports could be minimal. For these reasons it is important to select infrastructure projects with due consideration to balance of payments implications of such investment.
Besides all infrastructure developments do not contribute to production gains though they may contribute towards welfare and well-being of the community. What we are witnessing today is growth that is destabilising. It is now important to develop a growth strategy that is sustainable in the long run.


A steady rate of economic growth is a healthier development than booms and busts. To achieve high sustainable growth there is a whole gamut of policies needed. These include a certainty in economic policies, good fiscal management, an incentive-oriented environment and law and order. The focus of economic development strategies must be these conditions that are vital for economic development. It is by establishing these preconditions that higher investments that lead to higher growth could be achieved.

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