Sri Lanka: Risk Assessment
Country Risk Rating
Business Climate Rating
- Diversified agricultural production (tea, rice, coconut, rubber)
- Strategic location at the center of trade routes between Asia and the Middle East
- Indian, Chinese and Japanese interests
- Tourism in strong growth
- Vulnerability of agricultural production to climate disasters
- Low levels of capital public spending because of the burden of debt servicing
- Vulnerability related to reliance on short-term external financing
- Lack of infrastructure
Growth Should Remain Strong
Growth is expected to remain strong in 2018. A recovery is likely in the agricultural sector, which was heavily affected by the droughts and floods that hit the country in the first half of 2017. These episodes weighed on household consumption in 2017, as the shortage caused a temporary rise in inflation. This inflation is expected to slow down in 2018 against the backdrop of tighter monetary policy by the central bank in response to the gradual rise in key interest rates of the US Federal Reserve. Tourism should also benefit from better weather conditions.
The growth of the industrial sector is set to strong, stimulated by the reinstatement of the generalized system of preferences with the European Union (EU) since May 2017. This disappearance of tariffs for nearly 1,200 Sri Lankan products (including tea and other agricultural products, as well as various textile products) should greatly benefit the manufacturing sector, for which the EU is the largest export market. Uncertainties about Brexit conditions and its implications for UK growth, however, are expected to affect the sector, with the United Kingdom accounting for 30% of Sri Lanka’s exports to the European Union. The construction sector, meanwhile, will be boosted by government support for infrastructure projects and the positive impact of the takeover of the Hambantota port by the Chinese company CMPort in July 2017. This major investment project, combined with the government-led fiscal consolidation reforms under the auspices of the IMF and the relatively stable political climate, should reassure foreign investors and stimulate investment.
Public Finances Still Fragile Despite Gradual Improvement
Engaged in a process of fiscal consolidation with support from the IMF, the Sri Lankan government is continuing its efforts to reduce the deficit and debt. The priority of the reforms is to improve tax collection in particular. Foreign investments, such as those related to the Hambantota port, make it possible to generate revenues that are then used to reduce the debt. Nevertheless, the large share of some hard-to-reduce positions, such as the salaries of civil servants (representing 25% of government expenditures), will prevent the government from reversing this trend in the immediate future.
In terms of external accounts, the current account balance is expected to remain in deficit in 2018, with remittances from expatriate workers and tourism revenue only partially offsetting the deficit in the trade balance. The latter should nevertheless be reduced, with an increase in exports, and a decrease in fossil energy imports linked to a lower demand for thermal energy. In addition, despite expected growth, FDI would remain low compared to neighboring countries. As a result, the rupee is likely to remain under pressure.
Relative Political Stability in the Face of Persisting Destabilizing Factors
Since the 2015 elections, the political stability of the country has seemed assured. However, there is considerable tension between President Maithripala Srisena (Freedom Party) and his prime minister, Ranil Wickremesinghe (United National Party), making their alliance fragile. Discussions on the constitutional reform project that was launched in March 2016 are therefore difficult, and the oncoming local elections in January 2018 - initially planned for mid-2017 – presents a factor of instability.
Furthermore, tension remains between the Buddhist majority and the Muslim minority (9% of the population). In addition, Sri Lanka faces international pressure under the auspices of the United Nations Council, pending the government’s recognition of human rights violations, and the adoption of recommendations to sustain reconciliation between the Tamils and Sinhalese.
Improving the business environment is one of the government’s priorities, but accusations of favoritism and corruption are sometimes directed against leaders.