Sri Lanka Economy

With an economy of $18.4 billion (est. August 2004), and a per capita gross domestic product (GDP) of about $950, Sri Lanka enjoyed strong growth rates in recent years. Sri Lanka began to shift away from a socialist orientation in 1977. Since then, the government has been deregulating, privatizing, and opening the economy to international competition. The ethnic disputes of 1983 precipitated a slowdown in economic diversification and liberalization. The JVP uprising in the late 1980s caused extensive upheavals and economic uncertainty.

Following the quelling of the JVP, increased privatization, reform, and a stress on export-oriented growth helped revive the economy's performance, taking GDP growth to 7% in 1993. Economic growth has been uneven in the ensuing years as the economy faced a multitude of global and domestic economic and political challenges. Overall, average annual GDP growth was 5.2% over 1991-2000. In 2001, however, GDP growth was negative 1.4%--the first contraction since independence. Growth recovered to 4.0% in 2002 and 5.2% in 2003.

Foreign exchange reserves, which fell by 11% in 1999, decreased further in 2000. In response, the government floated the rupee on January 23, 2001. This led to a significant nominal depreciation in 2001, but the rupee has since stabilized and reserves have been replenished.

In 2003, continued peace allowed further progress on macroeconomic stabilization during the first half of the year. Some progress was reversed, however, during the political uncertainty in November and December 2003. Growth in 2003 was largely driven by the services sector (particularly telecom and tourism) and trade. Both exports and imports rose over 9% in the first 10 months. Interest rates declined. The inflation rate fell under 9%. External reserves were sufficient to cover 5.6 months of imports. The Colombo Stock Exchange (CSE) rebounded to become one of the better performers in the area. The CSE rose 45% in 2002 and hit a record high in June 2003 but performance declined at the end of the year. Fortunately, the severe acute respiratory syndrome (SARS) epidemic did not spread to Sri Lanka, and tourism was not severely affected. Sri Lanka's garment exporters reported a surge in orders, shifted from China due to SARS. On the negative side, in mid-2003 Sri Lanka experienced its worst floods in 50 years, which caused extensive damage in south and southwestern parts of the country.

Projections for 6.5% growth in 2004 did not account for political instability, which negatively impacted performance. The December 26, 2004 Indian Ocean earthquake and tsunami caused extensive damage in Sri Lanka. The human and environmental tragedy was enormous: over 30,000 people were killed and another 500,000 were displaced, and the bulk of the coastline was affected, leaving most fishing fleets destroyed. The United States is leading the international effort on relief and reconstruction, with damages estimated at $1.5 billion in Sri Lanka.

The future of Sri Lanka's economic health is uncertain but is primarily dependent on continued tsunami relief and reconstruction, political stability, continuation of the peace process, and continued policy reforms--particularly in the area of fiscal discipline and direct management. Implementation of major reforms in the civil service and education sectors and more disciplined spending and improved revenue collection would help generate stronger economic growth. If export orientation strengthens, weaknesses in government will have less impact on growth.

A strong global economy should help Sri Lanka maintain and even expand its export base, while effective aid utilization will be critical in the post-tsunami reconstruction effort. Rising oil costs in 2004, coupled with lower government revenue, held Sri Lanka’s fiscal deficit at about 9% of GDP. The government has indicated it intends to focus on better revenue collection mechanisms to deal with the problem. Post-tsunami investment needs may challenge government deficit reduction strategies over the coming years. Sril Lanka has a high debt burden (105% of GDP) and is reforming and modernizing its debt management structures.

Other challenges include diversification from Sri Lanka's key exports--tea and garments. Garment exports will face increased competition in a quota-free era when the Multi Fiber Arrangement expires in 2005. The future of the tea industry is threatened by a shortage of plantation labor and growing competition. There are new efforts to diversify exports, explore tourism potential, and improve competitiveness. The previous government had an ambitious information and communications technology strategy to connect and service every corner of the country. This project, if continued and implemented successfully, could change Sri Lanka's economy and social fabric and would take it into the information age. The government hopes to take advantage of Sri Lanka's strategic location on shipping routes, make use of the Indo-Lanka Free Trade Agreement, and sign free trade agreements with other countries to achieve regional trading hub status. If peace returns and all these efforts bear fruit, real growth could be in the 6%-7% range beyond 2004, and will help realize the government's intention of making Sri Lanka the gateway to South Asia.

The service sector is the largest component of GDP (54%). In 2003, the service sector continued its strong expansion, fueled primarily by strong growth in telecom, tourism, and financial services. Public administration and defense expenditures have remained steady. Repatriated earnings of Sri Lankans working abroad continued to be strong. There also is a small but growing information technology sector, especially information technology training and software development and exports.

Manufacturing accounts for about 16% of GDP. The textile, apparel, and leather products sector is the largest, accounting for 44% of total industrial output. The second-largest industrial sector, at 24% of total manufacturing output, is food, beverages, and tobacco. The third-largest industrial sector is chemical, petroleum, rubber, and plastic products. Agriculture has lost its relative importance to the Sri Lankan economy in recent decades. It accounts for 20.1% of GDP and provides employment to 33% of the working population. Rice, the staple cereal, is cultivated extensively. The plantation sector consists of tea, rubber, and coconut; in recent years, the tea crop has made significant contributions to export earnings and saw production slightly decrease in 2003. Tea prices have remained stable. The construction sector accounts for 7.4% of GDP and mining and quarrying 1.8%. In recent years, the government has eliminated many price controls and quotas, reduced tariff levels, eliminated most foreign exchange controls, and sold more than 55 state-owned companies and 20 estate-holding companies. Colombo boasts one of the most modern stock exchanges in the region, and the Sri Lankan Government offers a range of tax and other incentives to attract potential investors.