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Numerical Truth

The recently released Central Bank Annual Report 2016 had reflected almost every segment of the economy and gave us a macro picture about where the Sri Lankan economy stands. Numerical truth, this week attempts to analyse the Annual Report in nutshell.

According to the Annual report, the economic growth rate was 4.4 per cent in 2016 in real terms, in comparison to 4.8 per cent in the previous year, although a steady acceleration in quarterly growth was observed from the second quarter of the year amid tightened fiscal and monetary policies. Increased investment expenditure, especially in the construction sector, drove economic growth during the year, while consumption expenditure slowed in response to the policy environment in place.

Service sector continues to grow

Out of the three sectors, agriculture, industry and services, the latter continues to dominate the economy and grow at a faster rate than other sectors. According to the Annual Report, Services related activities, which constitute 56.5 per cent of real GDP, grew by 4.2 per cent in 2016, on a year-on-year basis, supported by the expansion in financial services, insurance, telecommunications, as well as transportation, and wholesale and retail trade.

Industry related activities, which account for 26.8 per cent of real GDP, recorded a notable growth of 6.7 per cent, year-on-year, driven by the subsectors of construction and mining and quarrying. Within the Industry sector, the growth in manufacturing activities was low at 1.7 per cent. Agriculture, Forestry and Fishing related activities contracted by 4.2 per cent in 2016, resulting in a reduction in their share in real GDP to 7.1 per cent in 2016. Adverse weather conditions that prevailed in 2016 resulted in a contraction, mainly in paddy, tea and rubber subsectors.

External sector instability

Despite the efforts of the government to increase exports, the external sector continues to be vulnerable due to the high external debt servicing payments. Accordingly, movements in external sector balances reflected the continued domestic demand for imports from certain sectors of the economy, weak external demand for the limited basket of domestic products, persistent failure of the country to attract increased direct investment flows as well as the impact of rising global interest rates particularly on the government securities market.

These developments resulted in the balance of payments (BOP) recording a deficit for the second consecutive year in spite of improvements in earnings from tourism and other service exports as well as workers’ remittances. The Central Bank’s heavy intervention in the foreign exchange market continued in the first four months of the year resulting in a broadly stable exchange rate during this period.

“Although the services account and the secondary income account recorded surpluses, the increase in the trade deficit and the primary income account deficit, caused the current account deficit to widen to 2.4 per cent of GDP in 2016 from 2.3 per cent of GDP in 2015. The subdued performance of the financial account of the BOP stemmed from continued outflows on account of debt repayments amid modest non debt inflows. In July 2016, Sri Lanka successfully raised US dollars 1500 million through its 10th International Sovereign Bond (ISB) which was its first dual-tranche issuance as well,” it was stated in the report.

It was identified that earnings from exports contracted in 2016 for the second consecutive year, mainly owing to the downward movement in commodity prices in the international market and modest economic recovery in Sri Lanka’s major export destinations. Despite the positive growth recorded in the latter part of 2016, earnings from exports at US dollars 10,310 million reflected a decline of 2.2 per cent, from US dollars 10,546 million in 2015, led by the declines in agricultural and industrial exports during the first seven months of the year. Export earnings declined mainly due to lower agricultural exports, which account for around one fourth of total exports. Earnings from agricultural exports declined by 6.3 per cent to US dollars 2,326 million in 2016, reflecting lower exports of many categories under agricultural products.

FDI and politics

Just like humans, governments too are entitled to dream. Government expectations regarding the Foreign Direct Investment (FDI) inflows are also far from expectations which remained at moderate levels in 2016. Total FDI inflows, inclusive of foreign loans to BOI companies, amounted to US dollars 1079 million, while direct investments that exclude foreign borrowings of BOI companies amounted to US dollars 898 million in 2016. In comparison, total FDI inflows with foreign loans in 2015 amounted to US dollars 1160 million, while the same excluding foreign loans amounted to US dollars 680 million. While the low level of FDI inflows have been a chronic issue in the Sri Lankan economy, FDI inflows during 2016 were affected by the evolving global economic outlook, in the backdrop of the interest rate hike by the US Federal Reserve. In addition, the significant increase in wage rates and other costs of production compared to peer-countries in the region would have been disadvantageous in attracting foreign investments to the country

Debt trap

As per the Annual Report, the central government debt to GDP ratio increased to 79.3 per cent by end 2016 from 77.6 per cent as at end 2015.

“This was mainly due to the increase in net borrowings and the modest economic growth during the year. In nominal terms, outstanding central government debt increased to Rs. 9,387.3 billion as at end 2016 from Rs. 8,503.2 billion as at end 2015. Within this, total outstanding domestic debt increased by 7.7 per cent to Rs. 5,341.5 billion, while total outstanding foreign debt increased significantly by 14.2 per cent to Rs. 4,045.8 billion by end 2016. In spite of improvements in many fronts, several drawbacks were observed in fiscal 9 operations primarily due to the sluggish implementation of structural reforms in tax administration,” the Annual Report stated.

Way forward

Economic challenges that the government will have to cope with many and not easy. The most dangerous challenge is the vulnerability of the external sector. It is getting bigger and bigger as the majority of the external borrowings will continue to be commercial. Hence as a short-term remedy import, substitution needs to be implemented.