The Central Bank (CB), echoing a commonly-held view in Sri Lanka though often rejected by ruling politicians, says that unstable policies are among a range of problems investors are confronted with in doing business in Sri Lanka. In comments which largely flow from concerns raised in previous year, the CB in its annual report for [...]

The Sunday Times Sri Lanka

Unstable policies cause of waning business interest in SL- CB

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File picture of an apparel factory in Colombo. Garments : Sri Lanka's biggest export

The Central Bank (CB), echoing a commonly-held view in Sri Lanka though often rejected by ruling politicians, says that unstable policies are among a range of problems investors are confronted with in doing business in Sri Lanka.

In comments which largely flow from concerns raised in previous year, the CB in its annual report for 2016 released last week listed ‚Äėpolicy instability‚Äô (12.9 per cent of the total list of issues) as the main reason why investors (local and foreign) are reluctant to do business here. The¬† other issues were access to financing (9.7 per cent), inefficient government bureaucracy (9.1), tax rates (8), tax regulations (7.8), inadequate supply of infrastructure (7.6), inflation (7.4), poor work ethic in national labour force (6.5), corruption (5.6), insufficient capacity to innovate (5.4), government instability (5.2), foreign currency regulations (4.7), inadequately educated workforce (4.4), restrictive labour regulations (3.7), crime and theft (1.7) and poor public health (0.1)

The report was presented to the President on Wednesday and earlier to the Finance Minister by Governor Indrajit Coomaraswamy.

The banking regulator in its much, looked-forward to annual report by business, economists, journalists, professionals, academics and students among others as a powerful reservoir of economic data and statistics, said that the Sri Lankan economy is projected to grow at a moderate rate of around 5 per cent in 2017 amidst the adverse impact of unfavourable weather conditions, and is expected to improve gradually thereafter to record an annual growth rate of 7 per cent by 2020.

The private sector is expected to play a key role in achieving this higher growth momentum by exploiting potential growth opportunities in the economy and external markets.

Economic expansion

‚ÄúAccordingly, economic expansion would be supported through increased investment from the private sector. Foreign investors are expected to contribute towards a higher level of investment with particular emphasis on services related activities and export oriented industries. The opportunities for the private sector would include the planned establishment of the Colombo Financial City, new opportunities under the Western Region Megapolis Project and the proposed establishment of economic corridors in the North East and South West of the island, and also in the areas surrounding the Hambantota and Trincomalee ports,‚ÄĚ the report said.

In addition to these initiatives, domestic investment activities are also expected to continue with emphasis on improving productivity through the adoption of new technology.

On the topic of issues and policies, the report said that the realisation of Sri Lanka’s envisaged medium term growth path is contingent upon addressing the deep rooted structural issues in the economy, which have prevented the country from maintaining a high and sustainable real GDP growth rate over time. Along with supportive fiscal and monetary policy measures taken in a timely manner, it is necessary to implement policies to address the structural issues in the economy aimed at improving productivity and efficiency, thereby resetting the growth trajectory of the country in order to harness its full potential in the medium term and beyond.

Declining earnings

It pointed out that although declining earnings from exports as a percentage of GDP have been partly due to weak external demand, the internal factors that have contributed to the continuation of such a trend cannot be ignored. ‚ÄúEarnings from exports contracted for the second consecutive year in 2016 and remained at a level lower than the earnings recorded five years ago. Being a middle income economy with comparatively high living standards, exporting the same primary commodities and low value added merchandise over the last two decades, and the limited manufacturing of complex and knowledge-intensive products, have hindered the growth prospects of Sri Lankan exports. This highlights the need for both product and market diversification. Producing more complex, high value added and more technologically intensive products, while integrating with regional and global production networks would act as a catalyst in Sri Lanka‚Äôs transition towards becoming an export oriented economy,‚ÄĚ the report added.

The CB noted that producing high value added products using minerals that are currently exported in primary commodity form is one strategy that needs to be pursued in this regard. It is necessary to implement a coordinated approach which stems from the current efforts of the government within its overarching development policy, to identify products and services or their components in the value chain for which Sri Lanka has a competitive edge, resurrect the manufacturing sector, attract FDI, and explore trade channels. Meanwhile, a market based exchange rate reflecting foreign exchange demand and supply conditions, reducing para-tariffs, which have contributed significantly to the economy becoming as closed as it was in 1970, and maintaining low and stable inflation as well as competitive wages would also ensure Sri Lanka’s export competitiveness.

Discussing foreign investments (FDI), the CB said that as evidenced by realised inflows, Sri Lanka’s attractiveness for FDI has remained low in spite of continued efforts to facilitate such investments. A reversal of this trend is urgently required. Failure to attract satisfactory amounts of FDI contributed to the high reliance on foreign debt to finance the current account deficit, increasing the country’s already high level of indebtedness. The strategies that are being developed by the government need to be implemented expeditiously with a view to attracting higher levels of FDI to the country, particularly in the backdrop of relatively higher FDI inflows to emerging market economies such as Vietnam, Myanmar and Bangladesh. Consistent domestic policies that are aimed at improving Sri Lanka’s competitiveness, strong institutional support and targeted promotional campaigns highlighting the potential of Sri Lanka as an attractive destination for investment would be instrumental in creating an enabling environment for FDI.

On the issue of jobs, the report said the unemployment rate declined to 4.4 per cent in 2016 (of the workforce) from 4.7 per cent in the previous year, while the number employed, increased by 1.5 per cent during the year with the expansion in the industry and services related activities in the economy. The reduction in female and male unemployment rates to 7 per cent and 2.9 per cent, respectively, in 2016, from 7.6 per cent and 3.0 per cent, respectively, in 2015, contributed to the overall decline in the unemployment rate.

During 2016, the unemployment rates by the level of education, declined across all categories, although unemployment amongst youth (15-24 years) increased to 21.6 per cent in 2016 from 20.8 per cent in 2015. Meanwhile, the Labour Force Participation Rate (LFPR) remained unchanged in 2016 at 53.8 per cent. Responding to policy actions by the government to minimise the social impact of unskilled female migration and the subdued economic performance in a majority of West Asia economies and other labour destinations, departures for foreign employment declined in 2016. However, the improvement in the skill profile of the temporary migrants contributed to a moderate increase in remittance inflows.

Meanwhile, labour productivity increased marginally during the first three quarters of 2016. Labour productivity in the agriculture sector remained at a level significantly lower than in the industry and services sectors.

Exchange outflows

On external developments, the CB said Sri Lanka’s external sector performance remained subdued in 2016, with foreign exchange outflows exceeding the moderate inflows during the year. The monetary policy normalisation in the US subdued external demand due to the slow pace of economic recovery in several advanced economies and emerging market economies, and persisting geopolitical tensions in West Asia, significantly dampened the performance of the external sector. The widening of the trade deficit, particularly in the last quarter of the year, and the primary income deficit led to a deterioration in the current account deficit during 2016, despite surpluses in the trade in services and the secondary income accounts. The subdued performance of the financial account of the BOP stemmed from continued outflows on account of debt repayments amidst modest non debt inflows. Meanwhile, Sri Lanka experienced outflows of foreign holdings from the government securities market during the year, and the Central Bank intervened in the domestic foreign exchange market to dampen the depreciation pressure on the Sri Lanka rupee.

The overall balance of the BOP recorded a deficit of US$500 million in 2016 while and the gross reserve asset position declined to $6 billion by end 2016, from $7.3 billion recorded at end 2015. With these developments, the rupee depreciated by 3.83 per cent against the US dollar in 2016.

Although the trade deficit contracted on a cumulative basis during the first four months of the year, it expanded significantly towards the end of the year. The expansion in the trade deficit was driven by the reduction in earnings from exports compared to 2015 and the substantial increase in import expenditure during the last quarter of the year. Accordingly, the trade deficit widened to $9,090 million in 2016 compared to $8,388 million recorded in 2015 and the trade deficit as a percentage of GDP increased to 11.2 per cent in 2016 compared to 10.4 per cent in 2015.

Earnings from exports contracted for the second consecutive year in 2016 with a contraction in earnings from agricultural and industrial exports. Low commodity prices in the international market, modest economic recovery of Sri Lanka’s major export destinations and disruptions in the domestic supply of export oriented agricultural products mainly contributed to the decline in export earnings by 2.2 per cent to $10,310 million. However, the removal of sanctions imposed on Iran by the US in January, and the lifting of the EU’s ban on seafood exports from Sri Lanka in June, cushioned the overall negative performance of exports resulting in a reversal of the year-on-year declining trend of exports towards end 2016.

Total FDI inflows, which include foreign borrowings by companies registered under the Board of Investment (BOI) amounted to $1,079 million during 2016 compared to $1,160 million recorded in 2015.

Total inflows to the government in the form of foreign loans increased to $2,163 million in 2016. These comprised project loans amounting to $1,278 million, two foreign currency term financing facilities worth to $700 million and programme financing amounting to $185 million.

The total external debt of the country increased during 2016 primarily due to the increase in external government debt. The outstanding external debt stock increased from $44.8 billion (55.7 per cent of GDP) at end 2015 to $46.6 billion (57.3 per cent of GDP) at end 2016. External borrowings by the government increased with the issuance of ISBs, foreign currency term financing facilities and the receipt of project loans. Capital repayments on external debt remained high at $3,157 million in 2016, although this was a moderation in comparison to $3,435 million in 2015.

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