Central Bank reports 6% GDP Growth Sri Lanka in

UNCLAS SECTION 01 OF 02 COLOMBO 000793

SIPDIS

STATE SA/INS; MCC FOR D NASSIRY AND E BURKE

SIPDIS, SENSITIVE

E.O 12958: N/A
TAGS: ECON CE
SUBJECT: Central Bank reports 6% GDP Growth Sri Lanka in

2005.



1. (U) Summary: According to the Central Bank, Sri Lanka's
economy grew by 6% in 2005 compared with 5.4% in 2004. Post-
tsunami reconstruction, debt moratoria and foreign grants

SIPDIS
and loans helped mitigate the adverse effects of the
December 2004 tsunami. Main contributors to growth were
telecommunications, exports, construction, financial
services and domestic agriculture. Foreign remittances of
USD 1.96 billion, mostly from Sri Lankan workers abroad,
helped to partially offset a USD 2.5 billion trade deficit.
While the budget deficit increased to 8.7% of GDP, there was
a notable improvement in government revenue. Inflation and
monetary expansion was high, but began to ease towards year
end. The Government expects economic growth to accelerate
to 6.9% in 2006. The Bank also highlighted the need for
additional structural reforms to improve growth prospects.
End Summary

GDP growth


2. (U) On April 27, the Central Bank released its 2005
annual report and announced that Sri Lanka's economy grew by
6% in 2005 - compared to 5.4% in 2004. Total GDP was USD 23
billion and per-capita income reached USD 1,197. All three
major sectors contributed to growth. Services, the largest
sector, accounted for 56% of the GDP, followed by industry
(27%) and agriculture (agriculture, fisheries and forestry)
(19%).


3. (U) The agriculture crop sub-sector (excluding fisheries
and forestry),which had been a drag on overall growth in
the recent past, bounced back strongly, growing by 8.8%, and
was a positive contributor to growth in 2005. Tea and rice
production reached record levels -- Sri Lanka achieved self
sufficiency in rice, helped by good weather and government
assistance (through an expensive fertilizer subsidy). Rice
production accounts for about 3% of GDP. Other non-
plantation agricultural crops also improved and contributed
8.5% of GDP. In the industrial sector, the manufacturing
sub-sector (including export industries) increased by 6%.
Construction expanded by 8.9% due to an expansion in
infrastructure and post-tsunami reconstruction. Services
grew by 6.4%. Telecommunications has grown strongly by 27%
and government services by 5.1%. While fisheries and tourism
contracted sharply due to tsunami damage, their small
contribution to GDP (less than 2% each),meant relatively
little drag on growth.

External Trade


4. (U) On the external front, the trade deficit expanded by
12% to USD 2.5 billion. However, this was partially offset
by strong growth in remittances. Worker remittances were
USD 1.9 billion and tsunami-related current remittances were
USD 50 million. As a result, the current account deficit
held at USD 650 million or 2.8% of GDP.


5. (U) Exports grew by 10.2% to USD 6.3 billion and imports
by 10.8% to USD 8.9 billion in 2005. The petroleum bill
increased by 37% to USD 1.65 billion, and accounted for
about 19% of the import bill. Sri Lanka's oil import bill
has doubled since 2003. Sri Lanka's key garment exports
increased by 3.1% and comprised 45.6% of overall exports.
Tea, rubber products and food products also recorded higher
growth rates. The US was the largest export market, with a
share of 31%.


6. (U) Foreign grants and loans (including tsunami
assistance) and debt moratoria helped to offset the current
account deficit and the Balance of Payment recorded a
surplus of USD 500 million. Foreign Direct Investment
inflow was USD 272 million. Consequently, external reserves
improved by 24%, to USD 4.2 billion, sufficient to cover 5.7
months of imports. The debt service ratio was 6.3% (exports,
services and remittances). The rupee appreciated slightly
in 2005.

Government finances


7. (U) Government fiscal performance has been mixed. The
government was unable to stick to fiscal targets and the
budget deficit increased to 8.7% of GDP from 8.2% of GDP in

COLOMBO 00000793 002 OF 002


2005.


2004. Government expenditure rose due to tsunami-related
expenses and a sharp rise in government expenses on
subsidies and salaries (due to new hiring and wage
increases). According to the Central Bank, the government
has spent about Rs 33 billion (USD 330 million) (1.4% of
GDP) on oil and fertilizer subsidies in 2005 (additional to
be settled bills still remain). Total defense spending was
Rs 82 billion (USD 820 million) (3.5% of GDP). Public
investment was 6.3 percent of GDP, including tsunami
reconstruction expenditure of 1% of GDP.


8. (U) On the positive side, total revenue increased by 22%
and amounted to 16.1% of GDP reversing a gradual decline in
revenue seen since 1999. Tax revenue increased by 20% to
14.2% of GDP. Total government debt stock has increased by
Rs 82 billion (USD 820 million),but as a ratio of GDP it
declined to 93.9% of GDP from 105% of GDP in 2004. This was
due to the appreciation of the rupee and the higher growth
in nominal GDP.

Inflation and monetary policy


9. (U) Monetary expansion was high in 2005. Average annual
inflation was 12% in 2005, and interest rates remained below
inflation. Money supply grew by more than 20%. Private
sector credit grew by 21.5%. In response, the government
increased key policy rates on four occasions. Together with
improved supply conditions, inflation declined from a peak
of 16% in February to 8% by December 2005, and showed signs
of further weakening in the first quarter of 2006. Monetary
expansion also showed signs of slowing by the end of 2005.
Interest rates remained below inflation in 2005.

Economic outlook for 2006


10. (SBU) According to the medium term macro economic
framework included in the report, GDP growth is forecast to
accelerate to 6.9% in 2006. According to the Central Bank,
a growth rate of over 8% is required to solve the problems
of unemployment (running around 8%) and poverty on a
sustainable basis. The Central Bank noted growth will
depend on restoring peace, inflationary control and slowing
monetary expansion. Inflation is expected to slow to 8% in
2006 (though the Central Bank Director of Economic Research
suggested to Econchief that he believes it will run at about
10% most of the year). Monetary expansion is targeted at
15%, a rate that Sri Lanka agreed to target during an IMF
visit in late 2005. The bank also warned that high oil
prices could cause problems to the Balance of Payments,
government fiscal control, exchange rate management,
inflation and further weaken the financial position of the
related state utilities. In order to mitigate oil price
effects, the bank has urged the government to adjust prices,
phase out subsidies and restructure energy related public
institutions. The Central Bank has also highlighted the
need to take on structural reforms to improve public
infrastructure, health and education and the efficiency of
public institutions. Further, the bank has identified the
need to enlighten the general public of the benefits of free
and liberal economic policies, structural reforms,
competition, the cost of protection and subsidies and the
role and limitations of the public sector.
ENTWISTLE