Cablegate: Sri Lanka: First Half Economic Performance

This record is a partial extract of the original cable. The full text of the original cable is not available.




E.O. 12958: N/A

1. Summary: After a year of declining indicators in 2001,
growth in the Sri Lankan economy turned positive in the
first half of 2002. Central Bank figures show that GDP
expanded by 0.1 percent in the first quarter, far off the
government's target of 3.7 percent growth for 2002.
Available data do not suggest a major recovery in the second
quarter, mainly due to the continuing sharp decline in
exports. The downturn in tourism, witnessed after the
terrorist attack at the international airport and the 9/11
attacks in the US, has continued through June 2002.
Inflation has remained high, but interest rates have come
down sharply following Central Bank rate cuts in 2001-2002.
The Colombo Stock Market was quite bullish in the first
half, although the indices lost ground in July in response
to news of political uncertainty, plantation wage demands
and weakening global equity markets. End Summary

GDP grows slowly
2. The Sri Lankan economy, which suffered a recession in
2001, moved back into the positive growth range, but just
barely, in the first half of 2002. Latest Central Bank
figures show that the GDP expanded by 0.1 percent in the
first quarter. This is far from the government's target of
3.7 percent growth in 2002, but an improvement on the
declines of 3.7 and 3.4 percent in the last two quarters of
2001. The Central Bank attributed the slow growth to
continued negative impacts such as drought, power cuts and
the global economic slowdown. The agriculture and services
sectors recorded growth rates of 2.4 percent and 1.4 percent
respectively. Paddy rice production in the main season
partly recovered, increasing by 6.1 percent after a 9.4
percent drop in the same period in 2001. Production of tea
declined by 10 percent during this period.

3. The main contributors to growth in the services sector
were telecommunications and transport. Telecommunications
continued its strong growth momentum begun in 2001,
expanding by a further 20 percent in the first quarter. The
transport sector also performed well, helped by the
expansion of services in the north and east after the
ceasefire. Banking performance slowed, due to stagnation of
interest income and fee based activities. External and
internal trading decreased by 2 percent in response to the
downturn in external trade.

4. The industrial sector declined by 4.2, with all
subsectors reporting contractions in output. Available data
do not suggest a major recovery in the second quarter,
mainly due to the continuing sharp decline in exports. On
the positive side, the daily power cuts were lifted in May
with the addition of emergency power generating capacity.
A good monsoon helped agriculture, with tea production
rising by 9.5 percent in the second quarter. Foreign
reserves stood at $2.23 billion at end of May 2002,
sufficient to finance 4.8 months of imports.

External trade
5. Trade figures for the first five months are not
encouraging. Exports and imports both recorded declines
through May 2002, and pushed the cumulative trade deficit in
the year to May up 4.2 percent to $734 million from $705
million in the same period in 2001. Export earnings dipped
by 16 percent to $1.676 billion during this period. The
market for Sri Lanka's exports continued to be affected by
sluggish demand from the US and EU. Textile and apparel
exports fell by nearly 20 percent to $824 million from
$1.023 billion. Agricultural exports declined by 1.8
percent. Exports to the US, Sri Lanka's main market,
dropped by 12 percent during Jan-May with apparel exports
declining by 6 percent and travel goods declining by 45
percent. On the import side, imports fell by 10.7 percent
to $2.41 billion. All categories of imports recorded

6. Tourist arrivals continue to suffer from the effects of
the terrorist attack at the international airport, violent
parliamentary elections, and the 9/11 attacks in the US.
Tourist arrivals in the first half of 2002 indicated a 24
percent drop to 173,136 compared with 227,205 in the first
half of 2001. Arrivals from the main markets, the UK and
Germany, dipped by over 40 percent during this period.
Arrivals from India rose sharply by 72 percent, a result of
increased promotional efforts by the national carrier, Sri
Lankan Airlines, and the tourist industry.

Inflation and Interest rates
7. Inflation remained high in the first half of 2002, but
interest rates have come down sharply from very high levels
in the first half of 2001. As of July, inflation is running
around 11.1 percent compared with 12.4 percent in July 2001.
Administered price revisions in 2001-2002 on fuel, utilities
(electricity and water), wheat flour, and transport are the
main factors contributing to inflationary pressures. The
Government is worried about the current high inflation, and
recently moved to lift a cost recovery surcharge on fuel in
a bid to mitigate inflationary pressures. In addition, the
exclusion of a some essential consumer items from the Value
Added Tax and inclusion of other essential consumer items
under the lower 10% rate should also help ease inflationary

8. In 2001, the Central Bank reduced interest rates by 850-
900 basis points. The Central Bank announced another 100
basis point reduction on interest rates on July 26, 2002,
citing improved liquidity in the domestic foreign exchange
and money markets and indicating lower inflationary
expectations. The weakness of US dollar has also reduced
pressure on the rupee and helped the Central Bank to cut
rates. Currently, 3 month T-bill rates average 11.25
percent compared with 18.25 percent in August 2001. Prime
lending rates average 13.43 percent compared with 20.44
percent in August 2001. The Central Bank is seeking to
raise about $350 million this year in international
financial markets in a bid to reduce pressure on the
domestic market, and ease interest rates. Broad money
supply (M2) grew by 15.9 percent in May. Domestic credit
expanded by 10 percent, with government credit expanding by
26 percent. Private sector credit grew more slowly, by 5.3

Stock Market
9. The Colombo Stock Market staged a partial recovery in the
first half of 2002, with the Colombo All Share Price index
moving up 14 percent from end-December levels. The Market
Price Earnings ratio moved to 9.9 in June 2002 from 7.5 in
December 2001. Total exchange turnover was approximately Rs
15 billion in the first half of 2002 compared with Rs 7
billion in the same period in 2001. Foreign investors
accounted for 24 percent of exchange turnover. Total net
foreign inflow was Rs 1.8 billion ($18.7 million) compared
with an outflow of Rs 1 billion ($11 million) in the first
half of 2001. Despite interest rate cuts, the stock market
lost ground in late July/early August reflecting political
uncertainty and plantation wage demands as well due to
negative sentiment in equities globally.

10. Comment: A period of readjustment is to be expected
after the events of 2001. This year will be one of recovery
for Sri Lanka, after external shocks and internal problems
caused negative GDP growth last year (for the first time
since independence). Though there are still constraints,
many positive factors are now in play: the enduring
ceasefire, an easing of the drought, some recovery in export
markets, a broad agenda of economic reforms, reliable power
supply. The effect of these factors will continue to be
modest until a lasting peace is in range, economic reforms
are in place and internal government frictions are reduced.
End comment.

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