The Sunday Times Economic Analysis                 By the Economist  

2004: From great expectations to uncertainty
The year that began as one of economic recovery and generated hopes of a better economic performance, moved to still higher expectations at mid year with the aid commitment and further evidence of the continuing cease-fire.

Then the economic expectations turned in the last two months into one of anxiety. It is unfortunate that the year must end on this note of uncertainty. These changes in expectations are captured in the initial expectations of a 5 per cent growth being raised to 5.5 per cent and then raised to even 6 per cent and then revised downwards to 5 per cent once again.

However, the Central Bank is confident that the economic growth of 5.5 per cent would be achieved. The fact is that the events in the latter part of the year will not be reflected in this year's economic performance. Their impacts will be in the coming years. What paths the constitutional issue takes would no doubt be the most important determinant of economic growth in 2004 and succeeding years. The constitutional problem is unfortunately embroiled within a political power struggle that is difficult to resolve.

The future performance of the economy will be very much dependent on political stability and peace. Whether the trajectory of growth will be better than the historical levels or below it, as has been in the recent past, or would regain its momentum would depend very much on these vital issues.

Since the political crisis was only in the latter part of the year, the economic performance for the year has been only marginally affected by these events. Therefore, to review the year's economic performance in terms of the uncertainty generated by the political events is misleading. There is no doubt that the year was one of economic recovery. The gradual recovery of the international economy, good weather, peace and security and a regaining of business confidence aided this recovery.

On the other hand, to characterise it as one of laudable economic achievement is an exaggeration. The 5 percent growth is in relation to the poor performance of previous years' poor economic record. It is indeed a statistical artefact. This year's economic growth is higher than last year's but as the economy has performed poorly in recent years, owing to both global and local conditions, this year's growth is not as impressive as it appears. As is well known the growth rate fell drastically to even register a decline of 1.4 percent in 2001. In 2002 there was a modest recovery of 4 per cent.

Therefore when we average the growth of the three years the annual average growth has been only about 2.7 percent, far below the average annual growth rate of around 5 per cent for the past two decades. This makes it essential that the country achieves a much higher rate of growth in the next few years. The components of the growth in the last year are also a matter of concern. The main source of economic growth has been the services sector.

The industrial recovery has been modest in the context of the poor performance of industries in the last two years. Industrial production has increased by only 5.1 per cent in the first ten months. Industrial export growth has been modest. Although industrial exports increased by 11 percent, this growth in industrial exports is less impressive when one realises that the industrial export earnings this year are lower than what we earned in the comparable period of 2000.

Although the focus has been on the export recovery and export growth this year, the trade deficit has grown to register a large deficit already. By the end of October it had risen to US$ 1.14 billion. The Central Bank has projected a trade deficit of US $ 1.7 billion by the end of this year. This is larger than last year's deficit of US$ 1.4 billion. Although exports grew, the growth in imports is expected to be much higher.

Despite this large trade deficit the balance of payments is expected to register a surplus of around US$ 300 million owing to income from services, remittances from abroad and net capital movements. However this surplus may be less or could turn into a deficit owing to the current political uncertainty changing the flow of capital in the last two months.

The public debt has risen and the fundamental problems in the public finances continue. The rates of interest and the rate of inflation have, however, declined. The significant issue is not the impact of the recent events on this year's growth. It is the stultifying impact that the political instability would have on the medium term economic growth. The projected growth rate for the next few years is much higher than the current growth rate. It was expected to be 6.5 percent to begin with and rising to 7-10 percent under a scenario that assumed progress in the peace process, inflow of substantial foreign aid and investments and a global economic recovery.

Already there are signs of withholding of foreign aid commitments and some of the expected larger foreign investments may be on hold. There is no way in which the higher growth rates could be achieved without the substantial flow of aid of US$ 4.2 billion. This aid is conditional on progress on the peace front.


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