Shiran Fernando analyses the main reasons for the slowdown of Sri Lanka’s economic growth in 2017

The 2017 annual economic growth indicator released in the second half of March revealed a sharp slowdown in GDP growth, easing to 3.1 percent from 4.5 percent in 2016. Despite the slump, initial GDP figures for 2017 indicate that the economy surpassed the US$ 4,000 per capita level to reach 4,065 dollars in 2017.

AGRICULTURE SECTOR The main reason for the slowdown is attributed to the impact of adverse weather with drought conditions prevailing in most parts of Sri Lanka last year. This was compounded by the flash floods of May 2017.

As a result of the ensuing supply shock, the agriculture sector contracted by 0.8 percent, which is lower than the decline in 2016 when the segment shrank by 3.8 percent.

The silver lining is that the last quarter of 2017 witnessed a notable improvement with an acceleration of 7.1 percent driven by base effects (as the fourth quarter of 2016 witnessed a contraction of 6.2%). Therefore, relative to the sector decline in 2016, last year did record an improvement of sorts in agriculture, which is a positive trend for 2018.

INDUSTRY AND SERVICES While the industrial sector grew by 3.9 percent in 2017, which was the highest by any economic sector, it was well below the growth recorded in 2016 (5.8%).

This was led by a sharp reduction in growth in the construction industry, which only rose by 3.2 percent relative to its 8.3 percent uplift in 2016. Base effects could be the cause of this despite projects continuing at a similar pace in 2017.

The services sector on the other hand, grew at its slowest in recent times under the new 2010 base.

A slowdown in consumption led to a substantial decline in subcategories such as transportation and education. The impact of higher interest rates and tighter fiscal policy through increases in indirect taxes could be the reason for growth being tepid in the services sector.

Moreover, the rise in the overall level of inflation in 2017, which was driven by a rise in the food and beverage category, is also a major reason for the tepid GDP growth.

OTHER INDICATORS GDP is not the only indicator providing insights into economic activity. There are other indicators that offer useful insights into growth and the performance of sectors. The quarterly Business Sentiment Index (BSI) of the Central Bank of Sri Lanka (CBSL) is one such indicator and is based on a survey.

According to CBSL, this survey takes into consideration entrepreneurs’ perceptions of business conditions in the current quarter and the outlook for the next quarter. It covers around 100 respondents.

In all four quarters of 2017, the index was below 100, which is an indication that business sentiment declined. Meanwhile in 2016, there were three quarters during which the index hovered above 100, which is indicative of positive business sentiment. A slump in sentiment in 2017 could reflect perceptions of economic activity, which is reflected in the slowdown in GDP growth. Subcategories of the BSI such as demand and sales were also at lower levels in 2017 compared to 2016.

The Purchasing Managers’ Index (PMI) looks at services and manufacturing. If the PMI indicates a register of more than 50, it would imply that the sector is generally growing on a month on month basis and vice versa when it is less than 50.

In 2017, the PMI for manufacturing was above 50 in all months except April, due to seasonal factors. Although this doesn’t indicate the expectation of a decline by sector participants, the movement of the index was more volatile in 2017 compared to 2016. The services PMI was also above 50 during all months in 2017 although it was lower than the value recorded in 2016 in most months.

QUARTERLY GROWTH The revision of initial GDP value estimates is not an uncommon practice in other countries. We have witnessed similar revisions in the US and UK, for example.

Much attention was paid to the release of the fourth quarter GDP figure as the initial growth projected on 15 March was withdrawn by the Department of Census and Statistics, which explained that more data was required to finalise the numbers. It was released a few days later.

However, revisions in the past have been quite significant with the first quarter 2017 figure revised down by 0.4 percent to 3.4 percent.

Weaker economic activity leaves monetary and fiscal policy in a quandary, and calls for a different strategy for either policy in order to redirect the economy towards a higher growth trajectory.