Sri Lanka: Economy

Sri Lanka is a lower-middle income developing nation with a gross domestic product of about $50 billion (official exchange rate). This translates into a per capita income of $5,100 (purchasing power parity). Sri Lanka's 91% literacy rate in local languages and life expectancy of 75 years rank well above those of India, Bangladesh, and Pakistan. English language ability is relatively high, but has declined significantly since the 1970s.

Sri Lanka's income inequality is severe, with striking differences between rural and urban areas. About 15% of the country's population remains impoverished. The effects of 26 years of civil conflict, falling agricultural labor productivity, lack of income-earning opportunities for the rural population, high inflation, and poor infrastructure outside the Western Province were impediments to poverty reduction. There are reports that poverty has been decreasing significantly in the last few years.

In 1978, Sri Lanka shifted away from a socialist orientation and opened its economy to foreign investment. But the pace of reform has been uneven. A period of aggressive economic reform under the UNP-led government that ruled from 2002 to 2004 was followed by a more statist approach under President Mahinda Rajapaksa.

Despite a brutal civil war that began in 1983, economic growth has averaged around 5% in the last 10 years. Due to the global recession and escalation of violence during the final stages of the war, GDP growth slowed to 3.5% in 2009 and foreign reserves fell sharply. Business confidence rebounded quickly with the end of the war and an International Monetary Fund (IMF) agreement in July 2009. Consequently, Sri Lanka recorded strong growth in 2010, as GDP grew by 8%. Official foreign reserves, including borrowings, reached $6.6 billion (5.9 months of imports). The post-war economic re-integration of northern and eastern provinces has boosted agriculture and fisheries, although a large area of agricultural land was damaged by floods in early 2011. Reconstruction of the war-damaged areas as well as infrastructure development throughout the country is also fueling growth. Tourism has rebounded strongly to record levels. Exports grew by a healthy 17% in 2010. Foreign remittance inflows from Sri Lankans working abroad swelled to $4.1 billion in 2010 from $3.3 billion in 2009. The Colombo Stock Exchange was the second-best performing market for the second year in a row. Inflation, which had reached double digit levels during the war years, was around 7% in 2010. Inflation pressures are building, and inflation reached 8.6% in March 2011. Foreign direct investment (FDI) remained relatively low in 2010 at about $450 million. The FDI target for 2011 is $1 billion, including investments in the tourism sector.

Government fiscal control remains a concern. The budget deficit reached almost 10% of GDP in 2009, but was forecast to fall to around 8% of GDP in 2010.

President Rajapaksa's broad economic strategy outlined in his 2005 and 2010 election manifestos, "Mahinda Chintana" (Mahinda's Thoughts), guides government economic policy. Mahinda Chintana policies focus on poverty alleviation and steering investment to disadvantaged areas; developing the small and medium enterprise (SME) sector; promotion of agriculture; and developing Sri Lanka to become the regional hub of ports, aviation, commerce, knowledge, and energy. The government has developed a 10-year development framework to boost growth through a combination of large infrastructure projects. The Rajapaksa government rejects the privatization of state enterprises, including "strategic" enterprises such as state-owned banks, airports, and electrical utilities. Instead, it plans to retain ownership and management of these enterprises and make them profitable.

The Mahinda Chintana plan aims to double Sri Lanka’s per capita income to $4,000 within 6 years. To do so, Sri Lanka requires GDP growth well over 8%, and the investment rate needs to rise from 25% of GDP to 35% of GDP.

Sri Lanka’s economy will continue its post-war resurgence and is expected to grow strongly in the immediate term. Although Sri Lanka should maintain moderate economic growth, Sri Lanka needs to enact important policy reforms to reach its full economic potential. Sri Lanka has set the goal of improving its business climate, but must follow through with reforms to decrease bureaucratic red tape; increase transparency, particularly in government procurement; and increase the predictability of government policies. Sri Lanka must also continue to improve its fiscal discipline. The 26-year conflict and high government expenditure have contributed to Sri Lanka's high public debt load (83% of GDP in 2009).

Sri Lanka depends on a strong global economy for investment and for expansion of its export base. It has been advised to diversify export products and destinations to make use of the Indo-Lanka and Pakistan-Sri Lanka Free Trade Agreements and to benefit from rapid economic growth in emerging East Asia. Sri Lanka's exports to the European Union qualified for duty-free entry under the EU Generalized System of Preferences (GSP) Plus market access program, granted in 2005 to help Sri Lanka rebuild after the 2004 tsunami. However, after a lengthy review process, the European Union suspended the GSP Plus market access benefit in August 2010, due to Sri Lanka’s poor human rights record. Nevertheless, Sri Lanka’s exports grew strongly by over 17% in 2010, despite the loss of this benefit. Sri Lanka continues to receive limited tariff preferences under the EU GSP program. Sri Lanka also receives preferential access to the U.S. market under the U.S. GSP program. This program has been temporarily suspended pending congressional approval.

The service sector is the largest component of GDP at almost 60%. In 2010, service sector growth increased to 8% from about 3% in 2009. Tourism, shipping, aviation, telecom, trading, and financial services were the main contributors to growth. Public administration and defense expenditures increased in recent years due to hostilities, and there has been an expansion of public sector employment. Despite the end of the war, defense expenditures remain at around 3.9% of GDP. There is a growing information technology sector, especially information technology training and software development.

Industry accounts for almost 30% of GDP. Manufacturing is the largest industrial subsector, accounting for 17% of GDP. The construction sector accounts for 7% of GDP. Mining and quarrying account for 2% of GDP. Electricity, gas, and water account for 2% of GDP. Within the manufacturing sector, food, beverage, and tobacco is the largest subsector in terms of value addition. Textiles, apparel, and leather is the second-largest sector. The third-largest sector in value added terms is chemical, petroleum, rubber, and plastic products.

Agriculture has lost its relative importance to the Sri Lankan economy in recent decades. It employs 31% of the working population, but accounts for only about 11% of GDP. Rice, the staple cereal, is cultivated extensively. The plantation sector consists of tea, rubber, and coconut; in recent years, the tea crop has made significant contributions to export earnings. Domestic agriculture such as rice and other food crops improved significantly with the return of peace to the eastern and northern provinces. However, floods in early 2011 destroyed many crops and livestock, including rice, in the main cultivation period.

Trade and Foreign Assistance
Sri Lanka's exports (mainly apparel, tea, rubber, gems and jewelry) were estimated at $8.3 billion and imports (mainly oil, textiles, food, and machinery) were estimated at $13.5 billion for 2010. The resulting large trade deficit was financed primarily by remittances from Sri Lankan expatriate workers, foreign assistance, and commercial borrowing. Sri Lanka must diversify its exports beyond garments and tea. The information technology (IT) and business process outsourcing (BPO) sector is small but growing.

Exports to the United States, Sri Lanka's most important single-country market, were estimated to be around $1.77 billion for 2010, or 21% of total exports. The United States is Sri Lanka's second-biggest market for garments, taking almost 40% of total garment exports. (The EU as a whole is Sri Lanka's biggest export market and largest apparel buyer.) India is Sri Lanka's largest source of imports, accounting for over 20% of imports. United States exports to Sri Lanka were estimated to be around $178 million for 2010, consisting primarily of machinery and mechanical appliances, medical and scientific equipment, electrical apparatus, wheat, plastics, lentils, and paper.

Sri Lanka is a large recipient of foreign assistance, with China, the World Bank, the Asian Development Bank, Japan, and other donors disbursing loans totaling almost $1.0 billion in 2009. China is a major lender for infrastructure projects, such as a new port, a coal power plant, and roads. Iran is also a major lender to Sri Lanka and has committed $450 million for the Uma Oya multipurpose irrigation project and $111 for rural electrification. Iran provides an interest-free credit facility for oil imports. Iran has also promised assistance for modernization of Sri Lanka's only oil refinery, though no firm commitments are in place. The Government of India is providing loans for the railway sector. Foreign grants amounted to $230 million in 2009. There continue to be problems with projects awarded without tenders.

Labor
The unemployment rate declined to 4.5% in fourth-quarter 2010, from 5.7% in fourth-quarter 2009. Unemployment is highest in the 20-29 age group. The rate of unemployment among women and high school and college graduates has been proportionally higher than the rate for less-educated workers. The government has embarked on educational reforms it hopes will lead to better preparation of students and better matches between graduates and jobs.

Approximately 20% of the 7.6 million-strong work force is unionized, but union membership is declining. There are more than 1,900 registered trade unions, many of which have 50 or fewer members, and 19 federations. Many unions have political affiliations. The Ceylon Workers Congress (CWC) and Lanka Jathika Estate Workers Union are the two largest unions, representing workers in the plantation sector. The president of the CWC also is Minister of Livestock and Rural Community Development. Other strong and influential trade unions include the Ceylon Mercantile Union, Sri Lanka Nidhahas Sevaka Sangamaya, Jathika Sevaka Sangayama, Ceylon Federation of Trade Unions, Ceylon Bank Employees Union, Union of Post and Telecommunication Officers, Conference of Public Sector Independent Trade Unions, and the JVP-aligned Inter-Company Trade Union.

Public sector trade unions usually resist government moves to restructure state-owned corporations. The Government of Sri Lanka has no plans to privatize any state-owned enterprises, and in some cases the government has reversed prior privatizations.

There are 1.7 million Sri Lankan citizens working abroad. A majority are women working as housemaids. Remittances from migrant workers, estimated at around $4.1 billion in 2010, is the most important source of foreign exchange for Sri Lanka, surpassing earnings from apparel exports.

Sources:

CIA World Factbook (April 2011)
U.S. Dept. of State Country Background Notes ( April 2011)

Glossary