STEADY GROWTH MOMENTUM

Shiran Fernando analyses Sri Lanka’s recent real GDP growth trajectory

Real GDP growth momentum continued in the third quarter of last year despite the election cycle. The July-September quarter reported growth of 5.5 percent to bring the first nine months acceleration of 2024 relative to 2023 to 5.2 percent.

This surpassed the expectations of most international and local forecasters who had expected the election cycle to slowdown growth.

So what are the reasons for this situation and expectations for 2025?

HEADLINE GROWTH Third quarter growth was impressive, given that there was little support from a low base in the same three months in 2023. In the first half of 2023, there was a contraction that provided some support for higher growth in the same term of last year.

Growth in the third quarter of 2024 was broad based with agriculture, industry and services growing by three percent, 10.8 percent and 2.6 percent respectively.

The growth in agriculture was higher than in the first half of 2024 but slower than what was recorded in the previous year. The sector was supported by growth in the tea (16.3%) and rice (4.3%) sub-sectors.

In the meantime, the construction and apparel industries registered strong performances. The former was supported by an expansion in credit to the private sector amid falling interest rates and the recommencement of government projects. There was also an increase in investment goods for construction purposes.

With the conclusion of the external debt restructuring process, key public investment projects such as the extension of the Bandaranaike International Airport (BIA), and Phases 1 and 3 of the Central Expressway, may recommence with bilateral financing or through a public-private partnership (PPP).

ABSOLUTE GDP Headline growth provides a relative comparison only to the previous year. For a true picture of the recovery, one must analyse the absolute numbers.

When the absolute numbers for the third quarter and first nine months of 2024 are analysed, they’re higher than what they were in the prior two years but still lower than the pre-crisis period (i.e. 2021 and before).

This means that the economy is still growing below its potential and yet to fully recover.

When analysing the sector composition of absolute GDP, it is the industry sector that’s mainly below the pre-crisis level while agriculture and services are at similar levels to what they have been over the past five to eight years.

Agriculture is largely sensitive to weather patterns and climate conditions while services are dependent on growth in tourism. Industry will likely revert to the pre-crisis level with recoveries in sectors such as food processing, apparel and construction.

CREDIT GROWTH Private sector credit from commercial banks is a key indicator that’s monitored to see the appetite to finance growth by individuals and private firms.

When firms or individuals borrow, it is likely to fuel consumption or investment led GDP growth.

In 2011, when GDP accelerated by 8.7 percent, private sector credit growth was 35 percent on a yearly basis. In 2019, when GDP contracted by 0.2 percent, the rise in credit was only four percent. It is not a strong correlation but credit growth does have an impact on GDP.

It is also dependent on interest rates, and political and economic stability. In 2025, with a single digit interest rate environment (i.e. the prime lending rate), it is likely that we will see double digit credit growth.

FOREIGN LENDERS Prior to its October 2024 report, the World Bank predicted growth for 2024 to be 2.2 percent. The bank later doubled its forecast to 4.4 percent. With the performance of the third quarter, it is likely that the 2024 full year forecast will be higher than 4.4 percent.

Though the World Bank’s 2025 forecast for Sri Lanka is 3.5 percent, the IMF and ADB are predicting growth to be 2.7 percent and 2.8 percent respectively.

Given the growth momentum seen in 2024, these will likely be revised upwards in future updates. The international forecasters will also wait to see the new government’s plans for growth in terms of macro and sector policies.

THE OUTLOOK With the completion of the external debt restructuring process, Sri Lanka will need to build buffers against external shocks as debt repayments commence. This will require export and services led investments that can generate export revenue.

In the case of agriculture, this requires investments in reducing post-harvest losses, and increasing productivity and output.

Niche sectors will need to be identified so that Sri Lanka can add value to its industrial output. For services, it is about expanding the country’s maritime and IT-BPM offering. As tourism returns to its 2018 peaks, we may begin to see accommodation, restaurants and tourism offerings increase.

If all these efforts are channelled within a stable policy environment, it augurs well for growth this year.