Sri Lanka: 8 Percent Growth Drives Central Bank Governor's

UNCLAS SECTION 01 OF 03 COLOMBO 001756

SIPDIS

SIPDIS

STATE FOR SCA/INS AND EB/IFD/OMA; MCC FOR D NASSIRY AND E BURKE

E.O 12958: N/A
TAGS: ECON EINV ETRD CE
SUBJECT: Sri Lanka: 8 Percent Growth Drives Central Bank Governor's
Optimistic Read on the Economy



1. Summary: Sri Lanka's Central Bank has reported 8 percent growth
and other positive economic figures for the first half of 2006.
Central Bank Governor Nivard Cabraal expects 2006 to finish with 7
percent GDP growth, reduced debt, lower inflation, and declining
unemployment. The government believes these trends can continue
over the 2007-2010 medium term. However, post agrees with the
assessment of a Sri Lankan economic think tank that peace and
economic reforms are necessary to realize this optimistic scenario.
End Summary.

1st Half of 2006: 8 Percent GDP Growth
--------------


2. Sri Lanka's Central Bank recently reported the following results
for the second quarter of 2006:

-- GDP growth for the quarter was 7.6 percent; GDP growth for first
half of 2006 was 8 percent.

-- Inflation was 13.4 percent for the quarter and 15.4 percent year
on year to September.

-- Unemployment declined to 6.3 percent in the second quarter from
7.7 percent in 2005.

Central Bank Governor's Optimistic Outlook
--------------


3. Sri Lankan Central Bank Governor Nivard Cabraal addressed the
American Chamber of Commerce in Colombo September 26 to discuss the
current Sri Lankan economy and its prospects for the next five
years. Calling his presentation, "Sri Lanka: The Time is Now,"
Cabraal asserted that many observers focused on the occasional
negative economic news but failed to report the positives. He
stated that his report would provide an "intentionally optimistic
perspective" that he hoped would "instill infectious confidence."
(Note: Cabraal delivered a similar presentation to the IMF, the
World Bank, and private bankers and credit rating agencies in
Singapore in mid-September.) Cabraal highlighted the following
statistics in his presentation, which took place shortly before the
bank published second quarter 2006 figures:

Economic Growth:

-- Overall 2006 GDP growth is projected to be 7 percent, compared to
an average growth rate of around 5.7 percent in the previous 3
years.

-- Production of key agricultural commodities is up, with paddy
(rice) recording a record harvest in the just-concluded main
cultivation season.

-- Construction, telecommunications, ports, and tourism are all
thriving. 2006 tourist arrivals are expected to reach pre-tsunami
levels, and per person expenditures are expected to rise.

-- The Colombo Stock market has risen steadily this year. (Note:
The All Share Price Index rose from 1922.2 in January to 2315.42 as
of September 26, 2006.)

Inflation and Money Supply:

-- Inflation was 15.3 percent in August, having declined from a peak
of 17.7 percent in June 2006.

-- Inflation is expected to decline to 10 percent by the end of 2006
and to a single digit in 2007.

-- Money supply growth is still high at 18.8 percent and needs to be
controlled.

Balance of Payments, Reserves, and Foreign Direct Investment:

-- Exports increased by 8.8 percent in the first half of 2006.
Imports grew by 20 percent.

-- Intermediate and investment goods imports increased sharply,
reflecting an expansion in the industrial sector.

-- Sri Lanka's oil import bill is up 40 percent to just over USD 1
billion in the first half of 2006. Total 2006 import volume of 30

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million barrels is expected to be about the same as in 2005, but
total 2006 expenditure is likely to be USD 2.4 billion compared to
USD 1.7 billion in 2005.

-- Remittances in the first half of 2006 are up 24 percent to USD
1.2 billion, and have helped to offset the rise in the oil bill.

-- The balance of payments remains positive as of August 2006.

-- Gross official reserves were USD 2.6 billion in August 2006, up
from USD 2.5 billion in December 2005.

-- Foreign Direct Investment has risen sharply in 2006, with USD 240
million committed in the first half of the year, exceeding the total
for all of 2005. For the year, Foreign Direct Investment could
reach USD 600 million.

Government Fiscal Operations:

-- Government revenue has increased by 18 percent in the first half
of 2006.

-- The government debt-to-GDP ratio is projected to decline to 90.5
percent in 2006 from 105.5 percent in 2004.

-- Central Bank-issued U.S. dollar denominated bonds offered to
local and foreign banks in Sri Lanka have been heavily
oversubscribed. (Note: The Government has raised USD 580 million so
far this year through these bonds. End Note.)
-- Interest rate margins on the above U.S. dollar denominated debt
have been falling. (Note: Rates are running at 130 to 151 basis
points over LIBOR in 2006 compared to a range of 143 to 225 basis
points over LIBOR between 2001 and 2004. End Note.)

Unemployment and Quality of Life:

-- The 7.4 percent unemployment rate is Sri Lanka's lowest in recent
times.

-- The government hopes to create better jobs, for example in the
business process outsourcing industry, by improving Sri Lankans'
employment skills.

-- Continued high literacy rate of 92.5 percent and life expectancy
of 73-75 years reflect good quality of life.

A Less Optimistic Assessment
--------------


4. The Institute of Policy Studies (IPS),a leading economic think
tank in Colombo, in its early October report, "Sri Lanka: State of
the Economy 2006," confirmed the trend towards 7 percent GDP growth
in 2006. However, the institute cited the following factors that
could undermine this level of growth:

-- Resumption of civil war.

-- Continued deficit spending and poor debt management, leading to
high inflation.

-- Failure to reform state-owned enterprises and government
regulatory practices.

-- Rigidities in land and labor markets.

Comment
--------------


5. In a recent meeting with donor countries and agencies, the
Central Bank's Department of Economic Research projected 2007-2010
growth in the range of 8 to 9 percent. It expected this growth to
come from trade, tourism, information technology, port operations,
manufacturing including apparel, construction, improved agricultural
productivity, and infrastructure investment. As the IPS assessment
notes, many of these sectors could be severely harmed by expansion
of the civil war, high inflation, and delayed economic reforms.
(Already, in the wake of the recent LTTE attack in Galle, the
government has lowered its 2006 tourism forecast.) The government
will need to address each of these challenges in order to meet its
projections.


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