US embassy cable - 04COLOMBO888

UNCLAS SECTION 01 OF 03 COLOMBO 000888 
 
SIPDIS 
 
SENSITIVE 
 
DEPARTMENT FOR SA/INS 
DEPARTMENT PASS TO USTR - JROSENBAUM AND AWILLS 
COMMERCE FOR ARI BENAISSA; MCC FOR DNUMMY 
 
E.O. 12958: N/A 
TAGS: ECON, ETRD, EAID, CE, USTR, ECONOMICS 
SUBJECT: Sri Lanka Exceeds 2003 GDP Expectations; Serious 
Questions Confront New GSL in Economic Arena 
 
Sensitive but Unclassified. Please handle accordingly. 
 
1.  (SBU) Summary:  The Sri Lankan economy responded 
remarkably well to continued peace and economic reforms in 
2003, and stymied naysayers who thought political 
instability during the final quarter would hurt overall 
growth.  GDP grew by 5.9%.  Per capita GDP rose to $947. 
There were commendable achievements in monetary policy 
management, fiscal (expenditure) control, and the trade 
sector.  Prospects for 2004 are uncertain due to 
conflicting economic rhetoric and welfare promises of the 
newly elected coalition government, which includes a 
leftist coalition partner.  If peace holds, however, and 
the international economy continues to expand (spurring 
export growth), economic growth in the 4-5% range is still 
possible.  However, long-term damage due to economic reform 
reversals could be substantial.  End Summary. 
 
2.  (U) The Sri Lankan economy performed well in 2003, 
largely the result of the continuing peace process between 
the GSL and the Liberation Tigers of Tamil Eelam (LTTE) 
terrorist group.  There had been considerable concern that 
economic growth would fall to less than 5.5%, due to 
political uncertainty that began during the last quarter of 
the Sri Lankan fiscal year. 
 
3.  (U) According to the Central Bank of Sri Lanka, the GDP 
expanded by 5.9% (compared to 4% in 2002 and -1.4% in 
2001), to $17.6 billion.  The higher growth is mostly 
attributed to peace and economic reforms begun in 2002.  It 
also indicates the strengthening of the private sector and 
strong export growth.  Significantly, per capita GDP (in 
this nation of 19.3 million people), rose by 8% to $947. 
The peaceful atmosphere in the country led to gains across 
all major sectors of the economy.  Services, industry and 
agriculture grew by 7.7%, 5.5% and 1.5%, respectively. 
Services sector is the largest economic sector contributing 
to 55% of GDP.  Industry and agriculture contribute 26% and 
19% of GDP, respectively. 
 
4.  (U) Tourism rebounded strongly in 2003, with tourist 
arrivals reaching the 500,000 mark for the first time. 
Telecommunications, transshipment through Colombo port, and 
banking activities all grew quite strongly.  In addition, 
property markets, not only in the capital but elsewhere, 
especially down the southern coastline, picked up. 
According to the Central Bank, employment has increased 
during 2002-2003.  Agriculture, construction, transport and 
communications sectors saw high job growth in 2003. 
 
5.  (U) Most other economic indicators also showed 
improvements in 2003.  The budget deficit was held to 8.0% 
of GDP, compared with 8.9% in 2002 and 10.9% in 2001, 
through expenditure control.  Significantly, defense 
expenditures declined to 2.7% of GDP in 2003 from 3.1% in 
2002.  In nominal terms, the actual defense bill was Rs 47 
billion ($480 million) in 2003, compared with an estimated 
requirement of more than Rs 100 billion ($1 billion) in the 
absence of peace.  Public investment increased to 5% of GDP 
from 4.6%, but was below the planned target of 5.3%. 
 
6.  (SBU) The achievements on the deficit front were in 
line with the new Fiscal Management Responsibility law, 
which aims to bring the deficit to 5% of GDP by 2006. 
Despite these achievements, falling government revenue 
remains a major problem.  Revenue fell to 15.7% of GDP in 
2003 from 16.5% in 2002.  Tax revenue dropped to 13.2% of 
GDP, much below the target of 15%.  The fall in government 
revenue was a major factor in the IMF's decision to hold 
back the first review under the PRGF.  Domestic financing 
of the government deficit declined substantially from 8% of 
GDP to 4.5% of GDP.  Privatization proceeds amounted to 
$105 million (0.6% of GDP). 
 
7.  (U) Due to lower domestic financing of the deficit, 
there were substantial gains in monetary management with 
Treasury bill interest rates falling to about 7.5% from 10% 
in 2002.  Similarly, the prime-lending rate was reduced to 
9.3% compared with 12% in 2002.  The gains in the monetary 
front are much steeper when compared with the high rates of 
18%-21% in 2000.  Inflation was brought down to 6.3% in 
2003 from over 10% in 2002-2001.  The Sri Lankan rupee, 
which has been continuously depreciating in the past 
several years, held steady despite political squabbles. 
Investment (22.3%) and domestic savings (15.7%) are still 
below desired levels.  Foreign investor flows were also 
quite meager with FDI at $181 million. 
 
8. (U) External sector performance was commendable. 
Exports increased by 9.2% to $5.1 billion in 2003, after 
declining in the previous two years.  Garments account for 
50% of total exports, with the US as the main buyer (61% of 
total exports).  Tea is second with 13% of total exports. 
The trade deficit expanded in 2003 to $1.5 billion, but 
private remittances from Sri Lankans abroad ($1.4 billion), 
services, FDI, and development assistance helped to 
restrict the current account deficit to 0.6% of GDP and 
post an overall Balance of Payments surplus (for the third 
consecutive year) of $502 million.  Consequently, external 
reserves increased to $3.2 billion providing 5.8 months of 
import cover.  The debt service ratio also declined. 
 
9.  (U) The Colombo Stock Exchange (CSE) performed very 
well in 2003 reaching its peak in October 2003.  This 
performance earned it the position of the world's second 
best performing stock market (Fortune).  Since then, 
business confidence has taken a beating -- despite a rise 
in corporate earnings -- due to political squabbles and the 
protectionist rhetoric of the new government.  Exchange 
indices remain 14% below their peak. 
 
10.  (SBU) Comment: The economic outlook is mixed.  2003 
was a better year than expected, but 2004 has been wracked 
with political uncertainty and continuing drought.  On the 
positive side, though certain segments of the current 
government coalition have espoused a shift to a "mixed 
economy" (during its campaign and since coming into power), 
from the largely free market economic policies of the 
previous government, some key UPFA leaders, including the 
Finance Minister, changed their stance once in office. 
Privately many officials have assured us that they intend 
to continue with the previous government's policies, albeit 
with some changes, including a greater focus on the rural 
economy.  This is understandable given the rural backlash 
during the election against the former government, as a 
result of a perceived lack of attention to the rural sector 
and poverty alleviation. 
 
11.  (SBU) Nonetheless, continued delay in the announcement 
of the Government's economic plan, news of potential fuel 
and fertilizer subsidies, conflicting statements on 
privatization, increased state employment and a fairly 
chaotic transition in the Finance Ministry have all fueled 
business sector worries.  (Note: the long-standing Deputy 
Secretary of Finance, widely seen as the key player on 
 
SIPDIS 
Finance matters resigned following an announcement that he 
would be "reassigned."  Headlines have also trumpeted a 
reported feud between the Finance Minister and Secretary 
(who is close to the President) on the direction of 
economic policy. End note.)  The Central Bank has already 
revised its growth forecast for 2004 from 6% to 5%, citing 
the effect of political disputes and the continuing 
drought. 
 
12.  (SBU) If peace continues, even in the absence of deep 
economic reforms, key sectors of the economy such as 
tourism, private remittances, and exports should hold 
steady at least in the short term (some export 
opportunities may be lost with the expiration of the Multi- 
Fiber Agreement in January 2005).  These sectors would also 
benefit from continued recovery in the international 
economy.  One or more negative developments such as a 
setback in the peace process, indications that electoral 
Marxist rhetoric was becoming a reality, continued 
political transition uncertainties, slow infrastructure 
investment, or increased unproductive state employment 
could hold back private investment, FDI inflows and 
economic growth.  There are teams from IMF and ADB in town 
this week and the Millennium Challenge Corporation team 
arrives next week.  Readouts from these visits should be 
interesting and a good gauge of whether or not the GSL has 
answers to the mounting economic questions it faces. 
Whether the new GSL is ready or not, though, it's clearly 
showtime.  End comment. 
LUNSTEAD