Economy poised for take-off

Muttukrishna Sarvananthan

The end of the war has created a new mood of confidence, but structural weaknesses hold back Sri Lanka from realising its economic potential

Muttukrishna Sarvananthan

Sri Lanka’s economy has proved remarkably resilient over the past decade despite the long continuation of the civil war that finally ended last year, the setback of the 2004 tsunami and the acute external shock of the global financial crisis. The question observers and investors are asking now is whether the country can really become the ‘miracle of Asia’ as the government of President Mahinda Rajapaksa likes to claim.

Just as the security and political pendulum has swung from one extreme to another, Sri Lanka’s economic pendulum has also experienced something rather similar. Between 2000 and 2009, annual GDP growth has ranged from the extremes of -1.5 percent in 2001 to 7.7 percent in 2006, standing at a midway point of 3.5 percent last year. Meanwhile, the annual average inflation rate soared to 22.6 percent in 2008 before falling back to last year’s low of 3.4 percent. With public debt high at not much below 100 percent of GDP, the budget deficit has see-sawed between 7 percent and 10 percent of GDP. Similar fluctuations have been seen in the balance of payments, the current account balance and the level of gross official reserves, the latter reaching $5,357 million last year.

These extreme fluctuations in macroeconomic indicators seem to reveal inherent structural weaknesses and vulnerabilities in the economy and yet the performance has been sufficiently encouraging – and the objective conditions are on the whole favourable for an economic take-off – now that the war is over. With better security and more political stability, there has already been a renewed boom in tourism, which is the country’s fourth largest foreign exchange earning sector after apparel exports, foreign remittances and tea.

Investor confidence is higher among foreign investors than local ones and this is reflected in activity on the capital market. However, the renationalisation of Sri Lankan Airlines, Sri Lanka Insurance, and Shell Gas has given a negative signal to potential foreign investors. Most privatisations of state-owned enterprises during the late-1990s have been reversed in the past couple of years, the one notable exception being Sri Lanka Telecom.

The agriculture sector’s contribution to the GDP has been consistently declining since the late 1970s, as might be expected in the development trajectory of an economy graduating from a low-income to lower middle- income during the course of the past three decades. But while agriculture’s contribution has fallen from 30 percent in the late 1970s to just 12.6 percent in 2009, the industrial sector has not grown commensurately, increasing only marginally from around 28 percent to almost 30 percent over the same period. Instead it has been the services sector – both public and private – that has largely contributed to Sri Lanka’s transition. While public services are beset with low productivity, private services perform better. The most dynamic private services during the first decade of this century have been apparel exports (with 20-25 percent value addition), the expansion of financial services and telecommunications (especially mobile phones), and shipping services.

Since the early 1990s, Sri Lanka’s exports have gradually diversified away from tea, rubber and coconut-based products to manufacturing garments for exports. But it has not gone much beyond low technology and low value-added apparel exports, which go almost entirely to just two markets (the USA and the UK) and there seems little hope for further expansion of the market in future. In the years ahead, the value of apparel exports seems likely to be overtaken by that of growing foreign remittances.

The government pins its hopes on further services sector-led growth and on making Sri Lanka an Asian hub for shipping, aviation, communications, tourism, and financial services. This development thrust is based on state-driven physical and economic infrastructure-led growth, including: roads (new ones and upgrading old ones across the country), the seaport, the airport, coal and hydroelectric power plants, and telecommunications expansion. But the sustainability of such public sector-led infrastructure development is questionable given the limited fiscal space, rising public expenditure and declining government revenue.

High levels of public sector employment, where productivity is low, are also eroding the competitiveness of the economy. Sri Lanka has one of the largest public sectors in Asia, with 1.3 million workers serving a population of around 20 million.

Despite greater access in Sri Lanka to primary and secondary school education than in most other Asian countries, the quality of school-based education is very poor as reflected in the outcomes of public examinations. Access to tertiary level education is limited and the formerly high standards have not been maintained. However, the government is seriously contemplating changing the existing laws to accommodate private universities – a policy designed to both increase access and to improve the quality of tertiary education. After decades of dithering by its predecessors, the present administration appears to be serious about reforming the education sector.

Corruption, nepotism, and political patronage are other barriers to Sri Lanka’s ‘miracle of Asia’ aspirations. Over-securitisation of the state in the post-war period, rather as too much medicine can harm a patient, could be detrimental to the country’s economic take-off. A balance needs to be found between security and development.

Although the conditions for economic growth in Sri Lanka now appear much more positive than in recent years, the country still needs to face up to and deal with a number of negative influences. The positive conditions clearly include the absence of war and the commanding parliamentary majority for the ruling party, but these could be undermined by over-reliance on the public sector to steer the development process and the bloated condition of the bureaucracy. Such impediments perhaps explain the government’s caution in aspiring to high single-digit GDP growth rather than the double-digit growth that might otherwise accompany Sri Lanka’s possible post-war boom.

About the author:

Muttukrishna Sarvananthan is Principal Researcher at the Point Pedro Institute of Development, Point Pedro, Sri Lanka


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