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Cablegate: Sri Lanka: 2007 Gdp Growth Reportedly 6.8%; Fitch

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RR RUEHLMC
DE RUEHLM #0366/01 1001100
ZNR UUUUU ZZH
R 091100Z APR 08
FM AMEMBASSY COLOMBO
TO RUEHC/SECSTATE WASHDC 7985
INFO RUCPDOC/DEPT OF COMMERCE WASHDC
RUEHNE/AMEMBASSY NEW DELHI 1956
RUEHKA/AMEMBASSY DHAKA 0830
RUEHIL/AMEMBASSY ISLAMABAD 7823
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RUEATRS/DEPT OF TREASURY WASHDC
RUEHLMC/MILLENNIUM CHALLENGE CORPORATION

UNCLAS SECTION 01 OF 03 COLOMBO 000366

SIPDIS

SENSITIVE

SIPDIS

STATE FOR SCA/INS AND EEB/IFD/ODF
STATE PLS PASS TO USTR

E.O. 12958: N/A
TAGS: ECON EINV EFIN KMCA CE
SUBJECT: SRI LANKA: 2007 GDP GROWTH REPORTEDLY 6.8%; FITCH
DOWNGRADES SOVEREIGN CREDIT RATING

REF: A. 07 COLOMBO 536 B. 07 COLOMBO 1305 C. COLOMBO 120

1. (SBU) Summary: Sri Lanka continued its healthy economic growth in
2007, reporting a 6.8% increase in real gross domestic product for
the year. Weaknesses in the government's statistical methodology
suggest the actual growth figure may have been lower, probably
closer to 6%. The reported outcome was below the 7.5% the
government had projected going into the year, but exceeded the Asian
Development Bank (ADB) expectation that renewed war would bring
growth down to 6%. Total GDP was $32 billion, yielding per capita
income of about $1,600. For 2008, the Central Bank of Sri Lanka
forecasts growth to be around 7%, whereas the ADB once again expects
6%. On April 2, Fitch Ratings downgraded Sri Lanka's sovereign
credit rating from BB- to B+, citing increased risk from inflation,
budget deficit, and worsened terms of trade arising from soaring oil
prices. The Fitch downgrade reflects the fact that, despite the
economy's overall resilience to the conflict, it has very little
leeway to weather a global economic downturn that could hit exports,
bring down remittances, and dry up the external credit that has
helped the government finance its chronic deficits. End summary.

GDP REPORTEDLY UP 6.8% IN 2007...
---------------------------------

2. (U) On March 28, Sri Lanka's Department of Census and Statistics
(DCS) released gross domestic product and other macroeconomic data
for 2007 showing that Sri Lanka's economy grew by 6.8% in 2007.
Though down nearly 1% from the revised 2006 GDP growth figure of
7.7%, the 2007 result demonstrated the economy's continued
resilience to the ongoing civil conflict. Total GDP was $32
billion, bringing per capita income up by 14% to $1,600. The
Central Bank noted that this outcome marked the first time Sri Lanka
has recorded GDP growth above 6% for three straight years.

... BUT MAY HAVE BEEN CLOSER TO 6%
----------------------------------

3. (SBU) The DCS statistics are not wholly reliable, as the
department uses unsophisticated data collection methodology and as a
result has to fill in many blanks with guesses. With the government
regularly announcing unrealistically ambitious growth targets, and
defensively lashing out when outside observers suggest that the
economy is not performing as well as the government claims, there is
pressure for DCS to embellish its numbers. Until mid-2007, the more
competent Central Bank produced Sri Lanka's GDP calculations, based
on DCS surveys of economic activity combined with data from other
sources such as industry bodies. A few years ago, DCS began
releasing its own calculation of GDP figures; DCS figures routinely
came in a few tenths of a percent higher than the Central Bank
numbers. For example, for 2006, DCS reckoned GDP growth at 7.7%,
whereas the Central Bank stated it was 7.4%. (Note: Ref A cited the
Central Bank figures, which we believed were more accurate.) When
the Central Bank stopped releasing its own GDP figures in 2007, it
told us it had done so because it considered the DCS figures
accurate and having two sets of figures was confusing.

4. (SBU) We have heard from multilateral development bank contacts
who have worked with DCS that its statistical methodology is
"outdated and simplistic" and that its task is further compromised
by poor private sector responsiveness to DCS's economic surveys.
This contact cited the fisheries sector as an example: DCS is unable
to actually track how many fish of what value are caught, so it
relies on indicators like the increase in the number of fishing
boats and an imputed increase in productivity to infer a quantity of
growth in the sector. Similarly, a former Central Bank statistician
recently wrote in an English-language newspaper that she had noted
to DCS seemingly inconsistent figures that the agency had difficulty
explaining. She cited a reported 9% growth rate in the construction
sector despite a decline in cement availability and a reported 7.8%
growth in domestic trade even though all categories of domestically
traded goods recorded growth below 7%.

5. (SBU) Post also noted some unlikely numbers in the DCS results
for 2007. For the first half of the year, DCS reported an annual
GDP growth rate 6.2% (ref B). For the second half, it reported that
the economy grew at a rate of 7.3%. DCS reported growth of 7.6% for

COLOMBO 00000366 002 OF 003


the fourth quarter, reporting double digit growth in the tea,
fisheries, hotels, communications, banking, and finance sectors.
These second half and fourth quarter figures strike us as
implausibly high.

6. (SBU) For the record, since the DCS figures are probably still
fairly accurate for comparative purposes, the following are the
sectoral breakdowns reported for 2007: Services and manufacturing
were the main drivers to growth. Services, which account for about
two thirds of GDP, grew by 7.1%. Within services, the main
contributors to growth were import/export trade, retail trade, port
services, telecommunications, and finance. Tourism recorded a 12%
decline, a direct result of the escalated conflict (ref C). The
manufacturing sector (including apparel), which accounts for about
19% of GDP, grew by 6.4%. Agriculture, which contributes about a
tenth of GDP, was up 3.3%. Rice, the staple cereal, declined after
two years of record growth. Tea production declined, yet had record
earnings due to higher global prices. Rubber production increased
and benefited from high global prices.

PROSPECTS FOR 2008: THE SAME 6-7% RANGE
---------------------------------------

7. (SBU) The Central Bank forecast 7% growth in the Financial and
Monetary Sector Road Map it released in January 2008. The Asian
Development Bank, in its recent 2008 Asian Development Outlook,
predicted the Sri Lankan economy in 2008 would grow by 6%. The ADB
expects growth to be held back by a slowdown in private sector
investment, weakening performance of the garment sector, and higher
oil prices. The ADB cited the economic slowdown in the United
States and the EU and escalation in the conflict as added downside
risks to economic growth. Weather has also begun to look like a
limiting factor for 2008 growth. Heavy rains have caused floods
that appear to have damaged 15-30% of Sri Lanka's rice crop.

FITCH SOVEREIGN CREDIT RATING DOWNGRADE
REFLECTS INFLATION, BUDGET AND TRADE DEFICITS
--------------------------------------------- --

8. (U) On April 2, Fitch Ratings downgraded Sri Lanka's sovereign
credit rating from BB- to B+, four tiers below "investment grade."
It cited Sri Lanka's "increased vulnerability...to adverse shocks
associated with rising inflation, persistently large fiscal deficits
and worsened terms of trade due to soaring oil prices in the context
of greater government recourse to commercial and market-based
financing." Fitch stated "increases in inflation and domestic
interest rates have led to greater foreign-currency borrowing by the
government." (Note: Although Sri Lanka's overall debt-to-GDP ratio
declined slightly in 2007 to 85.8%, its external debt load increased
from 43.4% to 44.1% of GDP.) Fitch noted that repayments on foreign
currency debt in 2008 will amount to $1.5 billion. Despite the
Central Bank's tighter monetary policy, Fitch "expects inflation to
remain relatively high, and...believes it will prove challenging to
reduce inflation significantly without inducing a sharp slowdown in
economic growth that would expose weaknesses in public finances."
Like the ADB, Fitch judged "a lasting and secure settlement of the
conflict is unlikely to be realized in the near term, and the risk
of disruptive terrorist attacks, despite the military gains made
against the LTTE, cannot be wholly discounted. Moreover, with the
management of the conflict being the overriding priority of the
President and government, fiscal reforms and other economic policy
issues are accorded less attention."

9. (SBU) The Central Bank in a press release dismissed Fitch's
concerns, as it did when Standard & Poor's not long ago downgraded
its sovereign credit rating outlook for Sri Lanka to "negative."
The Central Bank stated that reserves, remittances, and foreign
direct investment would be more than sufficient to cover the
country's debt service. A New York-based securities analyst who
follows Sri Lankan debt told Econoff that the Fitch downgrade would
perhaps add a little to the cost of Sri Lankan debt, which currently
yields over 10%, but was likely already mostly factored in. He
noted though that some institutional investors would have to stay
away from the debt at the new lower grade because their investment
guidelines would limit how far below investment grade they can go.


COLOMBO 00000366 003 OF 003

COMMENT: GROWTH IS REAL, BUT WITH PEACE
WOULD BE HIGHER AND BETTER DISTRIBUTED
---------------------------------------

10. (SBU) While the government may have yielded to the temptation to
pad its GDP growth statistics in the absence of solid data, a look
around the capital, the thriving Western Province, and even the
formerly sleepy Southern Province shows that the economy continues
its remarkable resilience in the face of the conflict and the
Rajapaksa government's anti-private sector bias. Cargo ships are
lined up into and out of Colombo Port. Tall buildings are going up
around Colombo. Road, rail, and port construction is underway in
the South. Shoppers are in the markets, new cars are on the
streets, and investors are looking at projects from renewable energy
to domestic aviation. The shame is only that conflict has
restricted this relative prosperity to only the West and the South.
If the rest of the country was peaceful and growing at comparable
rates, overall growth would easily hit the 8% level Sri Lanka needs
to make real progress against its remaining poverty.
BLAKE

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