SRI LANKA’S GROWTH STORY

Shiran Fernando reviews Sri Lanka’s growth trajectory with an eye on further stimulants

On the back of five percent GDP growth in the first half of this year, in its Sri Lanka Development Update for October 2024, the World Bank doubled its initial forecast of 2.2 percent growth for 2024 to 4.4 percent.

The World Bank says that economic stabilisation efforts have taken effect faster than expected. And to sustain them and improve growth with medium to long-term potential, Sri Lanka must stay the course and implement key structural reforms.

Therefore, it is necessary to explore the new government’s growth priorities and outlook for the economy in the coming year.

GROWTH IN 2024 Sri Lanka’s economy contracted for six consecutive quarters until the third quarter of last year. The turnaround in growth in 2024 is due to a rebound of the industry and services sectors, the latter driven by tourism.

Industry grew by 11.4 percent in the first half of the year as opposed to a 23.7 percent contraction between 2021 and 2023. Industrial growth can be attributed to improvements in the construction and food and beverage industries.

The services sector accelerated by 2.6 percent in the first half of 2024 relative to the same period in the previous year but the agriculture sector grew by only 1.4 percent due to disruptions during the Maha season.

Sri Lanka’s growth story is also supported by other proxies.

For instance, the Purchasing Managers’ Index for manufacturing, services and construction has been positive for several months, indicating that the second half of the year is also likely to maintain a growth momentum.

Other proxies such as electricity sales to industry and cement consumption are up – this is demonstrating that industry is displaying growth momentum.

OUTLOOK FOR 2025 Heading into new year, the economy will have to weather a few headwinds. In the aftermath of elections, the new government can work on implementing its policies.

Investment decisions by foreign and domestic investors are likely to resume, as they end their pre-election watch and wait strategy.

The foundation for acceleration in growth will be to remain with the IMF programme while continuing to improve fiscal and debt indicators. With the expected completion of the external debt restructuring process, Sri Lanka will also be able to improve its investment and credit rating outlook. This will assist the government and private sector to finance some of its growth through prudent borrowing strategies.

While growth resulting from tourism and industry are likely to continue in 2025, output from the agriculture sector will be highly dependent on weather patterns during the two main seasons.

Monetary policy will also play a crucial role through the demand for credit.

Though the Central Bank of Sri Lanka’s policy rates were cut by 0.75 percent during the year, lending rates haven’t yet fallen sharply.

The rate that banks are lending to prime customers has dropped to around nine percent but the average customer looking to borrow could be paying between 13 and 15 percent in interest.

This discourages investment decisions at household level for either consumption or investment. Similarly, SMEs that may be looking to expand through new products or by accessing new markets may not find these rates attractive.

Therefore, the Central Bank should consider cutting rates to reduce the lending rate further. However, banks should avoid keeping rates too low as they did in previous cycles since it may overstimulate demand and the economy.

EXPORT FOCUS The new government will need to focus on unlocking the barriers to exports.

In the early 2000s, Sri Lanka’s export of goods and services was above 30 percent of GDP. It has since been falling and hit a low of 15 percent in 2020. And with most years seeing imports outpacing exports, the country has had to contend with a current account deficit since 1977.

Despite opening the economy for trade in 1977, Sri Lanka has persisted with high barriers for exports and failed to attract foreign direct investment (FDI), which would have fuelled export diversification. Instead, tax holidays and other incentives attracted investments mainly in the construction industry and property related sectors.

There’s a strong possibility that this narrative can be changed.

The World Bank believes that Sri Lanka’s untapped export potential is about US$ 10 billion annually and could create 142,500 additional jobs.

Disruptions taking place in global value chains offer opportunities for Sri Lanka to plug in with innovative and authentic products. Coupled with free trade agreements (FTAs) that give countries access to over two billion people in the South Asian region, Sri Lanka can work towards being an export hub.

The World Bank is advising Sri Lanka to focus on reducing tariffs, facilitating trade, implementing the National Single Window and revamping the way the country attracts investments as possible building blocks in the effort to achieve this additional 10 billion dollars.