Economic Analysis
Sri Lanka

Sri Lanka

Population 21,107 million
GDP per capita 3849 US$
B
Country risk assessment
B
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Synthesis

major macro economic indicators

  2014  2015(f) 2016(f) 2017 (f)
GDP growth (%) 4.9 4.8 5.0 5.0
Inflation (yearly average) (%) 3.3 0.9 4.1 5.3
Budget balance (% GDP) -6.7 -6.9 -5.4 -4.7
Current account balance (% GDP) -2.7 -2.5 -1.9 -2.1
Public debt (% GDP) 70.7 76 77.2 75.5

 

(e) Estimate (f) Forecast

STRENGTHS

  • Diversified agricultural production (tea, rice, coconut, rubber)
  • Reduction of poverty
  • Human development and governance indicators higher than those of its South-East Asian neighbours
  • Indian and Chinese interests
  • Tourism growing strongly

WEAKNESSES

  • Marked dependence on the textile sector
  • Lack of infrastructure
  • Low levels of public capital spending because of the heavy burden of debt servicing
  • Vulnerability linked to dependence on short-term external financing

RISK ASSESSMENT

Growth expected to remain strong

After showing a slight increase in 2016, growth is expected to remain firm in 2017. The industrial sector should remain well positioned despite the monetary tightening initiated by the Central Bank. Construction should continue to benefit from the development of tourist facilities and infrastructure which is profiting from a USD 3bn loan from the Asian Development Bank. Tourism growth is likely to continue driving the whole range of service activities, which now account for over 60% of GDP.
However, the country has announced a fiscal consolidation programme, which could put pressure on the economy. The authorities have, in particular, decided to raise VAT from 11 to 16%, which is likely to hit household consumption, while expatriate remittances could decline, because many Sri Lankan workers are expatriates in the Gulf region, which is adversely affected by the low oil prices. Finally, in order to control the growth of credit and alleviate the downward pressure on the rupee, Sri Lanka's Central Bank has begun a process of gradual hikes in its key rates, which could have a gentle impact on household demand and investment. Nonetheless, after being deterred by the political uncertainties surrounding the two elections in 2015, foreign investment could rebound. Lastly, poor export performance by some agricultural products (tea and rubber especially) will be offset by good results for exports of cereals, coconuts and vegetables.
Inflation is likely to continue rising in 2017. Inflationary pressures will be fuelled by the fall of the rupee, higher VAT and slight upturn in commodity prices.

 

The public finances remain weak

The government's efforts to restore the health of the public finances have, to date, not gone far enough. However, in 2017, the budget deficit and the public debt are expected to fall, thanks to the fiscal consolidation programme put in place jointly with the IMF. The priority of these reforms is, notably, to improve the collection of taxes. However, the public debt will remain high and the country's budget vulnerability will still be substantial.
The current account deficit is expected to deteriorate because of the slight increase in oil prices and rising imports of consumer goods. This trade balance deficit will, in part, be offset by rising tourism revenues and substantial private transfers. Meanwhile, despite expected growth, FDIs will remain weak compared with those in neighbouring countries. As a result, the rupee is likely to remain under pressure against a background of expected US monetary tightening. The Central Bank's room for manoeuvre to contain downward pressure on the currency is limited: foreign exchange reserves cover hardly more than 3 months of imports.

 

Peaceful changeover in political power but there is considerable dissension within the new leadership team

2015 was marked by two elections which redrew the country's political landscape. To ensure his re-election for a 3rd term, President Rajapakse (Freedom Party) called early presidential elections in January 2015. Much to everyone's surprise, Maithripala Sirisena (former minister who joined the New Democratic Front following the announcement of elections) won the poll. Following the August 2015 parliamentary elections, Ranil Wickremesinghe (Freedom Party) became prime minister. Despite their wish to work together, numerous disagreements have surfaced between the prime minister and the president, both from different parties, and this alliance is fragile. 2017 will be marked by local elections which will test the unit of the prime minister's party.
Meanwhile, tensions between the Buddhist majority and the Muslim minority (9% of the population) remain acute. Furthermore, Sri Lanka is facing international pressure under the aegis of the United Nations ending recognition by the government of human rights violations and the adoption of recommendations enabling permanent reconciliation between Tamils and Sinhalese.
Finally, improving the business climate is one of the government's priorities, but accusations of favouritism and de corruption are sometimes levelled against the leaders.

 

Last update: January 2017

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