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Cablegate: Sri Lanka Exceeds 2003 Gdp Expectations; Serious

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

UNCLAS SECTION 01 OF 03 COLOMBO 000888

SIPDIS

SENSITIVE

DEPARTMENT FOR SA/INS
DEPARTMENT PASS TO USTR - JROSENBAUM AND AWILLS
COMMERCE FOR ARI BENAISSA; MCC FOR DNUMMY

E.O. 12958: N/A
TAGS: ECON ETRD EAID CE USTR ECONOMICS
SUBJECT: Sri Lanka Exceeds 2003 GDP Expectations; Serious
Questions Confront New GSL in Economic Arena

Sensitive but Unclassified. Please handle accordingly.

1. (SBU) Summary: The Sri Lankan economy responded
remarkably well to continued peace and economic reforms in
2003, and stymied naysayers who thought political
instability during the final quarter would hurt overall
growth. GDP grew by 5.9%. Per capita GDP rose to $947.
There were commendable achievements in monetary policy
management, fiscal (expenditure) control, and the trade
sector. Prospects for 2004 are uncertain due to
conflicting economic rhetoric and welfare promises of the
newly elected coalition government, which includes a
leftist coalition partner. If peace holds, however, and
the international economy continues to expand (spurring
export growth), economic growth in the 4-5% range is still
possible. However, long-term damage due to economic reform
reversals could be substantial. End Summary.

2. (U) The Sri Lankan economy performed well in 2003,
largely the result of the continuing peace process between
the GSL and the Liberation Tigers of Tamil Eelam (LTTE)
terrorist group. There had been considerable concern that
economic growth would fall to less than 5.5%, due to
political uncertainty that began during the last quarter of
the Sri Lankan fiscal year.

3. (U) According to the Central Bank of Sri Lanka, the GDP
expanded by 5.9% (compared to 4% in 2002 and -1.4% in
2001), to $17.6 billion. The higher growth is mostly
attributed to peace and economic reforms begun in 2002. It
also indicates the strengthening of the private sector and
strong export growth. Significantly, per capita GDP (in
this nation of 19.3 million people), rose by 8% to $947.
The peaceful atmosphere in the country led to gains across
all major sectors of the economy. Services, industry and
agriculture grew by 7.7%, 5.5% and 1.5%, respectively.
Services sector is the largest economic sector contributing
to 55% of GDP. Industry and agriculture contribute 26% and
19% of GDP, respectively.

4. (U) Tourism rebounded strongly in 2003, with tourist
arrivals reaching the 500,000 mark for the first time.
Telecommunications, transshipment through Colombo port, and
banking activities all grew quite strongly. In addition,
property markets, not only in the capital but elsewhere,
especially down the southern coastline, picked up.
According to the Central Bank, employment has increased
during 2002-2003. Agriculture, construction, transport and
communications sectors saw high job growth in 2003.

5. (U) Most other economic indicators also showed
improvements in 2003. The budget deficit was held to 8.0%
of GDP, compared with 8.9% in 2002 and 10.9% in 2001,
through expenditure control. Significantly, defense
expenditures declined to 2.7% of GDP in 2003 from 3.1% in
2002. In nominal terms, the actual defense bill was Rs 47
billion ($480 million) in 2003, compared with an estimated
requirement of more than Rs 100 billion ($1 billion) in the
absence of peace. Public investment increased to 5% of GDP
from 4.6%, but was below the planned target of 5.3%.

6. (SBU) The achievements on the deficit front were in
line with the new Fiscal Management Responsibility law,
which aims to bring the deficit to 5% of GDP by 2006.
Despite these achievements, falling government revenue
remains a major problem. Revenue fell to 15.7% of GDP in
2003 from 16.5% in 2002. Tax revenue dropped to 13.2% of
GDP, much below the target of 15%. The fall in government
revenue was a major factor in the IMF's decision to hold
back the first review under the PRGF. Domestic financing
of the government deficit declined substantially from 8% of
GDP to 4.5% of GDP. Privatization proceeds amounted to
$105 million (0.6% of GDP).

7. (U) Due to lower domestic financing of the deficit,
there were substantial gains in monetary management with
Treasury bill interest rates falling to about 7.5% from 10%
in 2002. Similarly, the prime-lending rate was reduced to
9.3% compared with 12% in 2002. The gains in the monetary
front are much steeper when compared with the high rates of
18%-21% in 2000. Inflation was brought down to 6.3% in
2003 from over 10% in 2002-2001. The Sri Lankan rupee,
which has been continuously depreciating in the past
several years, held steady despite political squabbles.
Investment (22.3%) and domestic savings (15.7%) are still
below desired levels. Foreign investor flows were also
quite meager with FDI at $181 million.

8. (U) External sector performance was commendable.
Exports increased by 9.2% to $5.1 billion in 2003, after
declining in the previous two years. Garments account for
50% of total exports, with the US as the main buyer (61% of
total exports). Tea is second with 13% of total exports.
The trade deficit expanded in 2003 to $1.5 billion, but
private remittances from Sri Lankans abroad ($1.4 billion),
services, FDI, and development assistance helped to
restrict the current account deficit to 0.6% of GDP and
post an overall Balance of Payments surplus (for the third
consecutive year) of $502 million. Consequently, external
reserves increased to $3.2 billion providing 5.8 months of
import cover. The debt service ratio also declined.

9. (U) The Colombo Stock Exchange (CSE) performed very
well in 2003 reaching its peak in October 2003. This
performance earned it the position of the world's second
best performing stock market (Fortune). Since then,
business confidence has taken a beating -- despite a rise
in corporate earnings -- due to political squabbles and the
protectionist rhetoric of the new government. Exchange
indices remain 14% below their peak.

10. (SBU) Comment: The economic outlook is mixed. 2003
was a better year than expected, but 2004 has been wracked
with political uncertainty and continuing drought. On the
positive side, though certain segments of the current
government coalition have espoused a shift to a "mixed
economy" (during its campaign and since coming into power),
from the largely free market economic policies of the
previous government, some key UPFA leaders, including the
Finance Minister, changed their stance once in office.
Privately many officials have assured us that they intend
to continue with the previous government's policies, albeit
with some changes, including a greater focus on the rural
economy. This is understandable given the rural backlash
during the election against the former government, as a
result of a perceived lack of attention to the rural sector
and poverty alleviation.

11. (SBU) Nonetheless, continued delay in the announcement
of the Government's economic plan, news of potential fuel
and fertilizer subsidies, conflicting statements on
privatization, increased state employment and a fairly
chaotic transition in the Finance Ministry have all fueled
business sector worries. (Note: the long-standing Deputy
Secretary of Finance, widely seen as the key player on

SIPDIS
Finance matters resigned following an announcement that he
would be "reassigned." Headlines have also trumpeted a
reported feud between the Finance Minister and Secretary
(who is close to the President) on the direction of
economic policy. End note.) The Central Bank has already
revised its growth forecast for 2004 from 6% to 5%, citing
the effect of political disputes and the continuing
drought.

12. (SBU) If peace continues, even in the absence of deep
economic reforms, key sectors of the economy such as
tourism, private remittances, and exports should hold
steady at least in the short term (some export
opportunities may be lost with the expiration of the Multi-
Fiber Agreement in January 2005). These sectors would also
benefit from continued recovery in the international
economy. One or more negative developments such as a
setback in the peace process, indications that electoral
Marxist rhetoric was becoming a reality, continued
political transition uncertainties, slow infrastructure
investment, or increased unproductive state employment
could hold back private investment, FDI inflows and
economic growth. There are teams from IMF and ADB in town
this week and the Millennium Challenge Corporation team
arrives next week. Readouts from these visits should be
interesting and a good gauge of whether or not the GSL has
answers to the mounting economic questions it faces.
Whether the new GSL is ready or not, though, it's clearly
showtime. End comment.
LUNSTEAD

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