Columns - The Sunday Times Economic Analysis

Economic growth and external financial stability

By Nimal Sanderatne

My recent columns focused on the external finances of the country and possible repercussions these may have on the economy. Much of the Central Bank stance was based on the fact that the economy is in a sound position and that the turbulence in the external finances were a temporary and transient phenomenon.

There is no doubt that the economy has been growing at a good pace, On the basis of the economic performance of the first half of the year, the estimates of economic growth for the year is between 7.5 percent to 8 percent. Nevertheless international developments play an important role in the performance of Sri Lanka's highly trade dependent economy. International developments in the next few months may determine the final outcome of the economy this year.

Economic growth

The government's expectation is that the economy would grow by 8.5 percent this year. Despite the reservations regarding the external finances of the country, the IMF too considers the economy's growth to be satisfactory, though its estimate is somewhat lower at 7.5 percent.

The IMF says, "Macroeconomic conditions remain satisfactory. The economy is expanding rapidly, with growth likely to come in around 7½ percent this year. As expected, headline inflation has moderated, reflecting declines in food and commodity prices, and there are as yet no clear signs of economic overheating." According to the estimates of the Department of Census and Statistics, the economy grew by an estimated 8.2 percent in the second quarter of 2011 in comparison with the same period in 2010. It was higher than the flood-affected first quarter growth performance of 7.9 percent. The economic growth in the first half of the year is 8 percent. This rate of growth on top of last year's growth of 8 percent is indeed an achievement. The sources of most of this growth are industry and services. Agriculture's contribution is expected to be somewhat less.

Agricultural production

While there is evidence that food crop agriculture has grown in recent months, there is a setback to the production of the country's main agricultural export.

Tea production has declined in the first 8 months contrary to expectations of a record breaking crop in 2011 at the beginning of the year. Tea production was however affected by adverse weather conditions and unrest in some plantations. Consequently tea production on the estates has been affected adversely and this year's production is likely to be lower than that of last year.

The tea crop for 2010 that grew by 13.1 percent from the low production in the earlier year to 329.4 million kilograms is likely to fall once again to less than that of last year. In the first 8 months tea production was less than that of last year at 220.8 million kilograms compared to the crop of 221.2 million kilograms during the corresponding period last year.

The main drop in production has been of tea production at medium elevation that declined by 7.3 percent or 2.7 million kilograms. On the other hand, High and Low Grown sectors have shown gains.

Growth sectors

The performance in the second quarter of this year is indicative of the sources and sectors of the economy's performance. In the second quarter of 2011, industry that contributes about 29 percent of the GDP grew by 9.4 percent and services, which have a 58 percent share of GDP, grew by 8.8 percent.

The growth in both these sectors was higher than that of last year. On the other hand, Agriculture which contributes only 12 percent to GDP has slowed to 1.9 percent in the second quarter. There is evidence that the growth in food crop agriculture will accelerate in the rest of the year. Rubber production too is expected to continue its increasing trend though the increase is moderate. In contrast, the expectation that this year's tea crop would exceed last year's record crop appears to be unattainable as tea production has fallen in the first eight months of the year.

Nevertheless owing to the lesser contribution of agriculture to GDP it will not drag down the overall performance of the economy.

Industrial growth has been impressive owing to a robust growth in most industrial exports. Overall growth in industrial exports has been an outstanding 42 percent in the first half of this year compared to the six months of last year. Garment exports have expanded by 35 percent and rubber goods exports increased by 86 percent. Other export industries that have performed well this year include leather goods and electrical and engineering products. Consequently production of these has increased.

Growing concerns

Despite these favourable developments in the first half of the year, there are anxieties that there could be a setback to these exports and therefore to industrial growth in the country. There are three concerns. First, the global economic conditions are not favourable. Most of these exports are to North America and Europe.

Economies of these countries are not doing well and the current evaluation is that these economies would not grow by much. Unemployment rate of above 9 percent in the US does not augur well for the Sri Lanka's export future and industrial expansion.

The second factor is that the currency has not depreciated owing to the Central Bank's policy of keeping the exchange rate stable. This could affect export competitiveness as other countries are depreciating their currencies. As pointed out in earlier discussions, the adequacy of reserves is not the issue with respect to export competitiveness.

The real effective exchange rate that factors in the costs of production and the value of other currencies are important determinants of our export competitiveness.

Tourist boom

There is no doubt that the country is experiencing a tourist boom. Tourist arrivals in the first eight months of the year increased by 35.2 percent to 537,787. There has also been a noteworthy change in the tourist profile of the country. Visitors from Western Europe increased with French, Italian and German tourists being prominent, while British tourists who have been traditionally large did not show an increase.
An important change is that there is increasing tourist traffic from newer destinations such as the Middle East, Eastern Europe and East Asian countries.

East Asian visitors and Japanese visitors rose 49.6 percent to 2,938 and Malaysian visitors increased by 49.9 percent to 1,568 and tourists from Singapore increased by 36.8 percent to 1,297. What is significant is not only the growth in tourism but the increase in tourism from new destinations. This augurs well for the future as global economic conditions would not make the tourist industry as vulnerable as when dependent on a few regions.

Cautious confidence

The economy has performed well so far but there are dark clouds on the horizon. Most significant are the slow growth of western economies, the turmoil in the Middle East that could affect tea exports and remittances and the management of the currency that could affect the country's export competitiveness.
The widening trade deficit to US $ 4.25 billion in the first half of the year and the consequent pressure on the balance of payments could have adverse impacts on our trade performance.

It is no doubt a critical period in the economy's recovery and growth that requires the correct and realistic economic policies to tide over the current difficulties to ensure sustained economic growth. Rapid growth of industrial exports must be ensured by the far-sighted management of the exchange rate.

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