US embassy cable - 02COLOMBO1452

UNCLAS SECTION 01 OF 02 COLOMBO 001452 
 
SIPDIS 
 
STATE FOR SA/INS, EB 
STATE PLEASE PASS TO USTR FOR FHUEGEL 
TREASURY FOR DO/GCHRISTOPOLUS AND ADNAN KIFAYAT 
MANILA FOR USADB 
 
E.O. 12958: N/A 
TAGS: ECON, EINV, ETRD, PGOV, CE, ECONOMICS 
SUBJECT: SRI LANKA: FIRST HALF ECONOMIC PERFORMANCE 
 
1. Summary:   After a year of declining indicators in 2001, 
growth in the Sri Lankan economy turned positive in the 
first half of 2002.  Central Bank figures show that GDP 
expanded by 0.1 percent in the first quarter, far off the 
government's target of 3.7 percent growth for 2002. 
Available data do not suggest a major recovery in the second 
quarter, mainly due to the continuing sharp decline in 
exports.  The downturn in tourism, witnessed after the 
terrorist attack at the international airport and the 9/11 
attacks in the US, has continued through June 2002. 
Inflation has remained high, but interest rates have come 
down sharply following Central Bank rate cuts in 2001-2002. 
The Colombo Stock Market was quite bullish in the first 
half, although the indices lost ground in July in response 
to news of political uncertainty, plantation wage demands 
and weakening global equity markets.  End Summary 
 
GDP grows slowly 
---------------- 
2. The Sri Lankan economy, which suffered a recession in 
2001, moved back into the positive growth range, but just 
barely, in the first half of 2002.  Latest Central Bank 
figures show that the GDP expanded by 0.1 percent in the 
first quarter.  This is far from the government's target of 
3.7 percent growth in 2002, but an improvement on the 
declines of 3.7 and 3.4 percent in the last two quarters of 
2001.  The Central Bank attributed the slow growth to 
continued negative impacts such as drought, power cuts and 
the global economic slowdown.  The agriculture and services 
sectors recorded growth rates of 2.4 percent and 1.4 percent 
respectively.  Paddy rice production in the main season 
partly recovered, increasing by 6.1 percent after a 9.4 
percent drop in the same period in 2001.  Production of tea 
declined by 10 percent during this period. 
 
3. The main contributors to growth in the services sector 
were telecommunications and transport.  Telecommunications 
continued its strong growth momentum begun in 2001, 
expanding by a further 20 percent in the first quarter.  The 
transport sector also performed well, helped by the 
expansion of services in the north and east after the 
ceasefire.  Banking performance slowed, due to stagnation of 
interest income and fee based activities.  External and 
internal trading decreased by 2 percent in response to the 
downturn in external trade. 
 
4. The industrial sector declined by 4.2, with all 
subsectors reporting contractions in output.  Available data 
do not suggest a major recovery in the second quarter, 
mainly due to the continuing sharp decline in exports.  On 
the positive side, the daily power cuts were lifted in May 
with the addition of emergency power generating capacity. 
A good monsoon helped agriculture, with tea production 
rising by 9.5 percent in the second quarter.  Foreign 
reserves stood at $2.23 billion at end of May 2002, 
sufficient to finance 4.8 months of imports. 
 
External trade 
-------------- 
5. Trade figures for the first five months are not 
encouraging.  Exports and imports both recorded declines 
through May 2002, and pushed the cumulative trade deficit in 
the year to May up 4.2 percent to $734 million from $705 
million in the same period in 2001.  Export earnings dipped 
by 16 percent to $1.676 billion during this period.  The 
market for Sri Lanka's exports continued to be affected by 
sluggish demand from the US and EU.  Textile and apparel 
exports fell by nearly 20 percent to $824 million from 
$1.023 billion.  Agricultural exports declined by 1.8 
percent.  Exports to the US, Sri Lanka's main market, 
dropped by 12 percent during Jan-May with apparel exports 
declining by 6 percent and travel goods declining by 45 
percent.  On the import side, imports fell by 10.7 percent 
to $2.41 billion.  All categories of imports recorded 
declines. 
 
Tourism 
------- 
6. Tourist arrivals continue to suffer from the effects of 
the terrorist attack at the international airport, violent 
parliamentary elections, and the 9/11 attacks in the US. 
Tourist arrivals in the first half of 2002 indicated a 24 
percent drop to 173,136 compared with 227,205 in the first 
half of 2001. Arrivals from the main markets, the UK and 
Germany, dipped by over 40 percent during this period. 
Arrivals from India rose sharply by 72 percent, a result of 
increased promotional efforts by the national carrier, Sri 
Lankan Airlines, and the tourist industry. 
 
Inflation and Interest rates 
---------------------------- 
7. Inflation remained high in the first half of 2002, but 
interest rates have come down sharply from very high levels 
in the first half of 2001.  As of July, inflation is running 
around 11.1 percent compared with 12.4 percent in July 2001. 
Administered price revisions in 2001-2002 on fuel, utilities 
(electricity and water), wheat flour, and transport are the 
main factors contributing to inflationary pressures.  The 
Government is worried about the current high inflation, and 
recently moved to lift a cost recovery surcharge on fuel in 
a bid to mitigate inflationary pressures.  In addition, the 
exclusion of a some essential consumer items from the Value 
Added Tax and inclusion of other essential consumer items 
under the lower 10% rate  should also help ease inflationary 
pressures. 
 
8. In 2001, the Central Bank reduced interest rates by 850- 
900 basis points.  The Central Bank announced another 100 
basis point reduction on interest rates on July 26, 2002, 
citing improved liquidity in the domestic foreign exchange 
and money markets and indicating lower inflationary 
expectations.  The weakness of US dollar has also reduced 
pressure on the rupee and helped the Central Bank to cut 
rates.  Currently, 3 month T-bill rates average 11.25 
percent compared with 18.25 percent in August 2001.  Prime 
lending rates average 13.43 percent compared with 20.44 
percent in August 2001.  The Central Bank is seeking to 
raise about $350 million this year in international 
financial markets in a bid to reduce pressure on the 
domestic market, and ease interest rates.  Broad money 
supply (M2) grew by 15.9 percent in May.  Domestic credit 
expanded by 10 percent, with government credit expanding by 
26 percent.  Private sector credit grew more slowly, by 5.3 
percent. 
 
Stock Market 
------------ 
9. The Colombo Stock Market staged a partial recovery in the 
first half of 2002, with the Colombo All Share Price index 
moving up 14 percent from end-December levels.  The Market 
Price Earnings ratio moved to 9.9 in June 2002 from 7.5 in 
December 2001.  Total exchange turnover was approximately Rs 
15 billion in the first half of 2002 compared with Rs 7 
billion in the same period in 2001.  Foreign investors 
accounted for 24 percent of exchange turnover.  Total net 
foreign inflow was Rs 1.8 billion ($18.7 million) compared 
with an outflow of Rs 1 billion ($11 million) in the first 
half of 2001.  Despite interest rate cuts, the stock market 
lost ground in late July/early August reflecting political 
uncertainty and plantation wage demands as well due to 
negative sentiment in equities globally. 
 
10.  Comment: A period of readjustment is to be expected 
after the events of 2001.  This year will be one of recovery 
for Sri Lanka, after external shocks and internal problems 
caused negative GDP growth last year (for the first time 
since independence).  Though there are still constraints, 
many positive factors are now in play: the enduring 
ceasefire, an easing of the drought, some recovery in export 
markets, a broad agenda of economic reforms, reliable power 
supply.  The effect of these factors will continue to be 
modest until a lasting peace is in range, economic reforms 
are in place and internal government frictions are reduced. 
End comment. 
Wills