A rapid economic growth
Since the end of civil war, economic growth has been sustained, averaging +7.4% per year. GDP per capita tripled from USD869 in 2000 to USD3256 in 2013, and economic transformation is ongoing. In particular, the economy appears to shift towards a higher value added production and the services sector is developing. After reaching +7.3% in 2013, growth should remain strong at +7% in 2014 and +6.5% in 2015, close to its ten-year average (+6.4%).
January 2015 elections will challenge the recent political stability
The ceasefire signed in 2009 ended 25 years of civil war, restoring political stability and improving international relations. However, the country has a history of fractious political parties, reflecting family and regional rivalries. The Tamil minority represents approximately 12% of the population and the government has done little to address the root causes of conflict with communal tensions increasing again.
President Mahinda Rajapaksa (United People's Freedom Alliance (UPFA)) won a resounding mandate in April 2010 parliamentary election. However, growing negative public perception about the government's economic performance in 2014 led the government to call for anticipated elections, which will take place on January 8 2015 (instead of January 2016). This could trigger higher political instability.
Sri Lanka ranks 99 out of 189 economies in the Doing Business 2015 survey, better than most economies in the region (India ranks 142). After the civil war, the government invested in infrastructures, mostly in the Eastern part of the country but further investment in this field would help sustain growth.
Lowering inflationary pressures
After a long period of sustained high inflation rates (averaging +12% from 2000 to 2008), inflation fell considerably. In October 2014, it eased to +1.6% y/y, its lowest level since 2009. Low food and oil prices are the key reason behind this deceleration. It should thus average +3.8% in 2014 before a modest pick up to +5.4% on average in 2015 reflecting drought conditions.
The Central Bank of Sri Lanka (CBSL) maintained its cautious accommodative stance with policy rate at 6.5% since October 2013. However, this did not translate into credit acceleration. Private credit growth fell to +7.5% in 2013, compared to +17.6% in 2012 and +34.5% in 2011. According to the IMF, banks are reluctant to lend, given the recent rise in nonperforming assets.
Weak public finances remain a cause of concern
Public finances remain are weak in Sri Lanka. Revenues represent only 12.4% of GDP in 2013. Subsidies and transfers are progressively being cut but still account for approximately 3% of GDP in 2014. As a result, public expenditures are relatively constrained (about 18.2% of GDP in 2013) and the fiscal deficit is large, representing -5.9% of GDP in 2013. It improved in 2014 (-5.2% of GDP) but should slightly deepen again given the upcoming elections: the 2015 budget proposes salary rises and increased spending, and the government also proposed
to raise government’s borrowing limits.
Public debt is high (above 70% of GDP) but on a decreasing trend since 2004 when it peaked at 102% of GDP. From 78.3% of GDP in 2013, it should reach 76.6% in 2014 and 74.6% of GDP in 2015. Over 40% of governmental debt is externally financed. Interest payments (5% of GDP) weight on government finances.
Improving external conditions but more efforts will be needed
Sri Lanka’s external position recently improved. From -6.7% of GDP in 2012, the current account deficit improved to -3.9% in 2013 and should stabilize at -3.3% of GDP in 2014. More restrictive policies on gold imports (duties raised to 10%) limited import growth. The economic recovery in the US and the UK (approximately 60% of Sri Lanka’s exports) helped boost goods exports in the second half of 2013 and into 2014. Services balance improved also thanks to tourism receipts Worker’s remittances (secondary income) account for over 8% of GDP and cushion the large trade deficit. Moreover, FDI are set to improve progressively (from 1.3% GDP in 2013 to 1.7% in 2014)
However more efforts will be needed to build strong external resilience. First, external debt is high, standing at 40% of GDP in 2013. It should slowly slow down, averaging 37.3% of GDP in 2014 and 34.9% in 2015. Second, currency risk remains a concern. From December 2012 to December 2013, the exchange rate depreciated by 14.4%. It has stabilized at approximately 130 Sri Lankan rupee per USD. Reserves ratios continue to show weaknesses. In July 2014, foreign reserves averaged USD8 bn, covering approximately 4 months of imports. However, reserves are quite fragile and have partly increased thanks to new borrowings. The government issued four different bonds in 2007, 2009 and 2014 (two international sovereign bonds totaling USD1.5 bn).