Growth and challenges: Sri Lanka’s economic prospects for 2011

In an attempt to apprise the business leaders in the country of contemporary challenges, the Institute of Chartered Accountants of Sri Lanka (ICASL) in collaboration with RAM Ratings (Lanka) Ltd. organised a CEO Forum earlier this week titled Sri Lanka’s Economic Outlook 2011 – ‘Sustaining the Growth and Rebuilding Momentum’.

By Cassandra Mascarenhas

The forum comprised of a presentation delivered by a representative of RAM Holdings which was then followed by a panel session headlined by noted industrialists and a representative from ratings agency Standard & Poor’s.

A global outlook

Dr. Yeah Kim Leng, Group Chief Economist of RAM Holdings Berhad, Malaysia as the keynote speaker started off proceedings with a presentation on Sri Lanka’s economic outlook for 2011.

Beginning with a quick synopsis on the current global economic update and its implications, he observed that although there has been a strong rebound, global recovery still remains fragile with demand still below the pre-crisis level.

Weakening industrial output (PMIs) in the second half suggests global demand may take a breather amidst continuing high unemployment in advanced economies. Weak domestic spending is exacerbated by uncertainty over sustainability of recovery in advanced economies caused by high fiscal deficits and debt levels coupled with weak credit growth as deleveraging and rebuilding balance sheet continues.

US recovery remains fragile as unemployment rate remains high at 9.6% while job creation remains weak. Government bailout, aggressive fiscal and monetary policy response and the resultant recovery have resulted in rising corporate profits but hiring remains weak.

It was noted that in Europe, Germany is leading the recovery with exports driving faster recovery in the country as unemployment shows steady decline. More labour-friendly measures taken by firms during economic downturn and higher labour productivity resulting in a faster pace of recovery of the German economy.

“Overall the global financial crisis has been stabilised but is still volatile, the European debt crisis may have another round with the problems we see now in Ireland for instance and Portugal not able to resolve their debt problems,” Leng said.

There is a now a shift in global demand to fast growing, large emerging economies. A substantial proportion of global growth over the next 3-5 years will be derived from large emerging markets, due to their inherent domestic demand arising from their large populations and high growth rates (averaging 8%-10% over the next five years).

Other developing countries can leverage on the shift in growth poles by restructuring production such that it will be complementary to the demand and output generated by these countries, rather than to be in direct competition against them.

Sri Lanka’s prospects

Moving onto Sri Lanka’s prospects, the economist stated that the country’s economy was poised for a strong rebound, showing a strong first half performance with a GDP of 7.1% in the first quarter and 8.5% in the second. There has also been recovery in exports and domestic demand.

Growth for 2010 estimated at 6.8% with the services sector expected to lead growth for the rest of 2010, expanding at an estimated 6.8% for the full year. Industry, led by manufacturing, is projected to expand by 6.5% in 2010.

Real GDP growth in 2011 is projected at 6.5%, and marginally lower at 6.3% in 2012. The services sector is projected to grow by 7.0% in 2011 and 6.9% in 2012, while industry, led by manufacturing, is projected to expand by 6.4% in 2011 and 2012.

Some key factors underpinning growth include post conflict infrastructure and reconstruction spending, modest growth in advanced economies but strong growth in India and China, the crowding-in of private investment especially FDI due to rising investor confidence and upward of growth outlook upwards.

A quick summary if Sri Lanka’s current standing and key risks in the near future summed up the presentation. It was observed that the country has had a strong rebound from 2008/09 global financial crisis - Sri Lanka’s GDP growth in 2010 has been estimated at 6.8% or nearly twice the 3.5% achieved in the previous year.

Employment and wage trends were identified as turning favourable. The threat of inflation has receded somewhat in 2010 but vigilance will be needed in 2011 as commodity prices rise. In turn the monetary policy should focus on growth as inflation increases.

“Sri Lanka needs to streamline many of its procedures which would in turn increase the ease of doing business. For example, Sri Lanka has more procedures involved in obtaining licences and permits to build a warehouse, compared to other South Asian country. Tax administration could be streamlined and revised to boost the efficiency of the overall system. This could be hindering your price sector as the tax is twice the amount,” Leng said.

Number of procedures in property registration in Sri Lanka exceeds the regional average. Nonetheless, costs are still lower than those of its South Asian peers. There is much scope to further strengthen the country’s financial infrastructure, in terms of the collection and dissemination of credit information (for both individuals and firms). There is a need to increase the level of transparency and accountability concerning transactions in the country, to encourage a higher level of economic activity.

Economic prospects in 2011 and 2012 have improved considerably with GDP growth forecast at 6.5% and 6.3% respectively. Medium-to-long term growth prospects revised upwards; average annual GDP growth raised to 6.2% from 5.5% for 2011-15 period while the earlier 6.0% forecast for 2016-20 has been raised marginally to 6.1% as the country’s long term potential has increased.

Risk to growth in post-conflict era has receded but several potential areas need monitoring such as prolonged weakness of the advanced economies, accelerated inflation due to commodity price shocks, the slow pace of reforms, investors’ perception of increased fiscal weakness and the inability to diversify domestic production structure.

Transition of economic power

This was followed by the panel discussion which ratings company Standard & Poor’s Regional Head for South Asia Roopa Kudva kicked off with a short presentation of her own. Starting with the global economy, the economic recovery in the US was identified as being a ‘half-speed’ recovery with weak consumption spending which has resulted in growth projection for 2010 lowered to 2.6% from 3.3%.

The recoveries in the EU and the UK were affected by the situation in Greece which aroused fears of a widespread financial collapse have eased due to concerted action but fiscal tightening and elevated unemployment will weigh on domestic demand.

On the other hand, developing economies, especially in Asia, have strong growth prospects. Asian banks’ capitalisation remains adequate and can drive credit growth and surging capital inflows have led to sharp currency appreciation but this may trigger ‘currency wars’.

“The next two decades are going to see a perceptible change in the economic powers from the West to the East – a trend that is supposed to accelerate over the next two decades,” she noted.

Key points raised by Kudva included developing countries having better prospects due to economic uncertainty that still prevails in the advanced economies, South Asia in particular having strong growth prospects, but inflation will remain a concern.

In relation to Sri Lanka, S&P expects Sri Lanka will grow 6.5% in 2010, and 6.8% in 2011 – the expected economic reforms under the IMF program and the return of peace that has improved investor confidence key factors when coming to these conclusions. It was noted though that fiscal risks may remain due to Sri Lanka’s high debt and interest burdens.

Government and private sector

Chairman of Laugfs Holdings Limited W.K.H. Wegapitiya aired his ever-candid opinions following the two presentations, calling the topic at hand a very crucial one. He also predicted a cabinet reshuffle which could in turn throw the predictions made for the coming year off balance, criticising the country’s policy makers and politicians for not providing a stable enough backdrop for economic development.

“We now have one of the most conducive economic environments. One of the key mistakes or weaknesses is not having a consistent economic policy – we have never had a strong capable government in place. Now it is available but still, what one visualises will happen and what actually will happen are two different things,” he said.

Both the Government and the private sector need to do in order to go ahead, was what the Chairman of the Ceylon Chamber of Commerce Anura Ekanayake had to say, further stating that the growth projections made by both forecasting agencies were far below the potential Sri Lanka is really capable of.

He went on to say that a sharp change will be needed to boost Sri Lanka into the top twenty in the world ratings which is what the CCC has been aiming for with successive governments over the years but have so far not been able to make much of an impact.

Ekanayake also discussed the upcoming budget, hoping that it will bring about the necessary reforms needed, such as to the taxation regime which would in turn result in a surge of growth even without an increase in investments.

 “We urge policy makers to make the necessary changes needed immediately; just because we have huge potential, it does not mean that we can just sail through - instead certain things must be done. If we just coast along the way we are doing now all we can get is one percent growth. If we can make all the changes, 8% growth is a feasible target,” Ekanayake stated.

Heated Q&A session

The panel discussion and presentations in turn stimulated a heated Q&A session which was curbed only by the time restrictions imposed.

One question posed was what steps should be taken by the private sector which has been accused of not playing a vibrant enough role in economic development.

The Chairman of the CCC answered this, explaining that the private sector does need to discuss this issue. The sector needs to concentrate on giving clear, unambiguous messages to the Government and recognise the fact that we have now entered a new economic scenario from the one the country had gotten used to for 30 years which was persistent inflation and enormous uncertainty and instability in the system amongst other issues.

“The end of the war has created a significant change – what me must realise is that the economic power is shifting from the West to the East, The private sector is still catering 60% to the US, EU and Japan. We need to start looking at trading more with China, India and South East Asia and how we can factor in single digit inflation and interest rates into our business plans. There is a lot that the private sector as well as the Government has yet to do,” he said.

The next question was regarding how to respond to the short term money coming in that is threatening the export net growth and what action should be taken by the Central bank to counter this.

This has been identified as a region-wide problem. There is increasing concern with the return of capital control especially in small emerging markets; perhaps they can consider some sort of controls. There are both short and long term issues.

For any central bank trying to manage exchange rates, inflation and interest rates, something has to give as it is hard to balance it all. Look at the world – there are now fundamental shifts with strong capital flows coming in from the West to the East. The reason for this is that western countries just don’t have growth.

“It is also critical to ensure that they move to FDI rather than portfolio investments and make long term investments in your country. Asian countries cannot be purely export led growth, there is a lot more infra-regional trade happening. There are short term issues but we have to recognise that this is a trend that is not going to go away,” said Kudva.

In response to yet another question posed by a member of the audience, Wegapitiya stated that the Government is trying to get into the areas in which the private sector can invest in and requested that such opportunities should be given to the private sector.