SRI LANKA Quarterly Economic Update

SRI LANKA Quarterly Economic Update April 212

SRI LANKA Quarterly Economic Update April 212

212 Asian Development Bank All rights reserved. Published in 212. Printed in the Philippines. ISBN 978-92-992-764-8 (Print), 978-92-992-76- (PDF) Publication Stock No. RPS124783 Cataloging-In-Publication Data Asian Development Bank. Sri Lanka quarterly economic update. Mandaluyong City, Philippines: Asian Development Bank, 212. 1. Economic development. 2. Sri Lanka. I. Asian Development Bank. The views expressed in this publication are those of the authors and do not necessarily reflect the views and policies of the Asian Development Bank (ADB) or its Board of Governors or the governments they represent. ADB does not guarantee the accuracy of the data included in this publication and accepts no responsibility for any consequence of their use. By making any designation of or reference to a particular territory or geographic area, or by using the term country in this document, ADB does not intend to make any judgments as to the legal or other status of any territory or area. ADB encourages printing or copying information exclusively for personal and noncommercial use with proper acknowledgment of ADB. Users are restricted from reselling, redistributing, or creating derivative works for commercial purposes without the express, written consent of ADB. Note: In this publication, $ refers to US dollars. 6 ADB Avenue, Mandaluyong City 1 Metro Manila, Philippines Tel +63 2 632 4444 Fax +63 2 636 2444 www.adb.org For orders, please contact: Department of External Relations Fax +63 2 636 2648 adbpub@adb.org Printed on recycled paper

Contents Macroeconomic Developments 1 Overview 1 Sector Performance and Economic Growth 1 Inflation 2 Monetary and Financial Developments 3 External Sector Developments 4 Fiscal Performance

iv Sri Lanka Quarterly Economic Update Country Director Team Leader Team Members R. O Sullivan, Sri Lanka Resident Mission (SLRM), SARD T. Hayashi, Senior Country Economist, SLRM, SARD H. Wickremasinghe, Senior Economics Officer, SLRM, SARD I. De Silva, Economic Consultant, SLRM, SARD S. Jayakody, Associate Economic Analyst, SLRM, SARD NOTE The fiscal year (FY) of the government ends on 31 December.

Macroeconomic Developments Overview To address economic imbalances in the second half of 211, the Government of Sri Lanka took policy measures which included monetary tightening, the removal of foreign exchange controls, and the introduction of fuel and power tariff increases. Getting the right balance between inflation and economic growth is important for monetary policy. As growth rates in Sri Lanka are starting to decline, the government may face a fiscal policy dilemma between maintaining the level of capital expenditure and containing the fiscal deficit. Exports and tourist arrivals are gradually slowing. But they still recorded positive growth in early 212 on the whole. Sector Performance and Economic Growth The Sri Lankan economy grew by 8.3 in the fourth quarter of 211 (Figure 1). Per capita income reached Rs313,11 ($2,836). Both services and industry sectors recorded strong growth. Services sector made the biggest contribution to gross domestic product (GDP) at 6.2, while industry made up 3.4 of total GDP, and agriculture contributed 9.4. The services sector grew by 8. during the last quarter of 211, driven by higher growth rates in the wholesale and retail trade, and transport and communications. The hotels and restaurants sector recorded 21.3 growth due to the inflow of tourists. Transport and communications grew by 11.2, while its share of GDP as a subsector increased to 14.6 from 14.2. The industry sector expanded most among the three sectors, growing 1. in the fourth quarter of 211. Improved demand, both domestically and externally, contributed to the increase in industrial production. The construction subsector led the growth, with a 14.4 expansion driven by large-scale development projects, and rehabilitation and resettlement programs in the Northern and Eastern provinces. Factory output rose by 8.2, led by export-oriented industries, despite the global economic slowdown. Manufacturing grew by 7.7. Figure 1 (Supply) 1 8 6 4 2 2 4 6 GDP Growth Q1 Q2 Q3 Q4 Q1 Q2 Q3 Q4 Q1 Q2 Q3 Q4 29 21 211 Agriculture Industry Services GDP GDP = gross domesic product. Source: Department of Census and Statistics of Sri Lanka. 1

2 Sri Lanka Quarterly Economic Update The agriculture sector grew by 2.4 in the fourth quarter of 211, down from 6.1 in the previous quarter. Tea saw negative growth along with rubber, coconut, and minor export crops, while paddy cultivation was strong. Private investment expanded by 1.9 in 211. New machinery and equipment will boost production capacity. Figure 2 Contribution to GDP (Demand) On the demand side (Figure 2), consumption rose 13. during the whole year 211, and continued to remain the main driver of economic expansion. On the other hand, the balance of trade figure for negative net exports doubled. Private investment, the key for sustainable economic growth, expanded by 1.9 in 211, the highest growth among domestic demand items. Public investment also recorded a robust 1 increase in the year. Investment for machinery and equipment continued to expand strongly in 211, and in turn that will increase production capacity within the economy. 1 1 - -1 28 29 21 211 While total investment in current prices increased as a share of GDP to 29.9 in 211, from 27.6 in the previous year, domestic savings contracted to 1.4 from 19.3. Rising investment coupled with falling domestic savings widened the savings-investment gap to 14.6 in 211, from 8.3 in 21. Net Export Consumption Public Investment Change in Stock Private Investment GDP Inflation Source: Central Bank of Sri Lanka. Energy prices were adjusted in February to narrow the gap between the domestic and international prices. Figure 3 Inflation (year-on-year) 1 1 Inflation in Sri Lanka recorded by the Colombo Consumer Price Index (CCPI), started to increase, rising to. in March and 6.1 in April 212 (Figure 3). Falling food prices pushed down inflation during January March 212, but they rose marginally (.2) in April. Nonfood inflation, which had increased gradually throughout 211, jumped by double digits to 12.9 in March. This was due to adjustments in February to narrow the gap between domestic and international energy prices. (Ceylon Petroleum Corporation lost Rs94 billion or 1.4 of GDP in 211, up from Rs27 billion or. of GDP in 21, largely due to the sale of heavy fuels to Ceylon Electricity Board at subsidized rates). Diesel and petrol prices were raised by 37 and 9 respectively (Table 1), and a surcharge (2 4) was imposed on household electricity bills. As a result, among the sub-categories of the CCPI, transport costs rose more than 3 year-on-year in March 212 (Figure 4). 211 212 Food Non- Food All Items Source: Department of Census and Statistics of Sri Lanka

Macroeconomic Developments 3 Table 1 Domestic Fuel Prices Date Petrol Price per litre (Rs) Diesel Price per litre (Rs) Jan 21 11 73 Apr 211 12 76 Dec 211 137 84 Feb 212 149 11 Source: Lanka Business Online. While the energy price hike in February will technically push up yearon-year inflation over the following 12 months, 1 month-on-month inflation reflects latest price developments. Seasonally-adjusted 2 month-to-month inflation reached 3.1 in March 212, and was driven by non-food inflation of 4. due to the energy price shock, and also by food inflation of 1.9 (Figure ). In April, while non-food inflation eased, a further jump in food inflation to 2.6 maintained the high rate of overall inflation. Monetary and Financial Developments Credit to the private sector grew at 34. in 211 and has kept up that pace, reflecting continued expansion of economic activity (Figure 6). It recorded 34. growth in April 212, reaching Rs2,18 billion (the equivalent of 33 of GDP in 211). Net bank lending to the government increased by 47.4 in April 212 compared with the same month in 211. Strong expansion in the broad money supply (M2b) therefore continued, recording year-on-year growth of 22.9 in April 212. Interest rates have also been increasing since November 211. The Central Bank of Sri Lanka tightened its monetary policy in February 212, and raised the policy rates by basis points (Table 2). The repurchase (repo) rate and the reverse repo rate were increased to 7. and 9. respectively to curtail import-related credit to reduce the trade deficits, and contain inflation at the mid-single-digit levels in the second half of 212. The central bank has also directed commercial banks to moderate lending so that overall credit growth in 212 will not exceed 18 of their loans outstanding at the end of 211. Additional credit growth is allowed for finance using funds mobilized from overseas. Figure 4 Inflation by Subcategories (year-on-year) 3 3 2 2 1 1 - Tran sport -1 211 212 Fo o d an d No n Alcoholic Beverages Clo th ing an d Footwear Housing, W ater, Electricity, Gas etc Furn ishing an d Household Eq uipment H ealth T ran s port C o m m un ication Recreatio n and Culture Ed uc ations M is c ellaneous G oods an d Serv ices Source: Department of Census and Statistics of Sri Lanka. Figure Inflation (month-on-month) (seasonally adjusted) 4 3 2 1-1 -2-3 Food 211 212 Non- Food Source: Department of Census and Statistics of Sri Lanka. All Items

4 Sri Lanka Quarterly Economic Update Figure 6 Monetary and Financial Indicators 6 4 3 2 1-1 211 212 Government Sector Credit (annual growth, left) Private Sector Credit (annual growth, left) 3- Month T-Bill (right) Weighted Average Prime Lending Rate (right) Figure 7 Stock Indices and Non-national transactions Index The Central Bank of Sri Lanka tightened monetary policy, raising policy rates in February and April. M2b = consolidated broad money supply. Source: Central Bank of Sri Lanka. 1, 8, 6, 4, 2, -2, -4, -6, Sale (right) 211 212 All Share Price Index (left) Net Purcahse (right) Purchase (right) Source: Central Bank of Sri Lanka, Weekly Economic Indicators 3 2 2 1 1-2, 16, 12, 8, 4, -4, -8, -12, Milanka Price Index (left) Exports and imports are slowing, and the trade deficit is shrinking. Earnings from tourism and workers remittances were robust. Figure 8 Export, Import and Trade balance 1 8 6 4 2-2 -4 Rs million Table 2 Policy Rates () Date Repo Rate Reverse Repo Rate Statutory Reserve Requirement 12 Jul 21 7.2 9. 7. 2 Aug 21 7.2 9. 7. 11 Jan 211 7. 8. 7. 29 Apr 211 7. 8. 8. 3 Feb 212 7. 9. 8. Apr 212 7.7 9.7 8. Source: Central Bank of Sri Lanka. To ensure a smooth deceleration of credit growth and to anchor inflation expectations, the central bank in April 212 further increased the repo rate to 7.7, and reserve repo rate to 9.7. The statutory reserve requirement has remained unchanged at 8. since April 211. Stock prices declined in 211, but the trend has flattened in 212. The All Share Price Index fell 8. during 211 and the Milanka Price Index of more liquid stocks fell 2.9, and closed at 6,74 and,229, respectively at the end December 211. The indices stood at,44 and 4,861, respectively, as of end April. Non-nationals were net buyers during January February 212. External Sector Developments Exports and imports are slowing down (Figure 8). Exports saw yearon-year decreases in October 211, January, March and April 212. In April, exports recorded a decline of 9.2 and imports decreased by 3.3. Growth in exports of agricultural and textile goods has decelerated, while consumer and intermediate goods caused reduction in total imports. With exports and imports recording $.7 billion and $1.4 billion respectively, the monthly trade deficit decreased from $1.1 billion in November 211 to $.8 billion in April 212. Tourist arrivals from Western Europe recorded the highest number in 211. As a result of the high base effect caused by high number of tourist arrivals in 21 and 211, the year-on-year growth in tourist arrivals from all the regions have been decelerating since the latter part of 211. Earnings from tourism expanded by 26 in the first quarter of 212 to $34 million. Workers remittances to Sri Lanka in March 212 went up by 9.2, bringing in $ million. 211 212 Export growth Import growth Source: Central Bank of Sri Lanka.

Macroeconomic Developments Gross official reserves (excluding Asian Clearing Union balances) amounted to $.7 billion, or 3.3 months of imports, in March 212, down from $8.1 billion in July 211 (Figure 1). The central bank s intervention in the foreign currency market to defend the value of the Sri Lanka rupee against the US dollar decreased gross official reserves and drained domestic liquidity. Following a 3 devaluation of the rupee against US dollar in the last week of November 211, the central bank decided in February 212 that it would limit its intervention in the foreign exchange market, moving toward greater market determination of the exchange rate. By April 212, the exchange rate reached Rs128.7/$1, a 14 depreciation from its value a year earlier. The International Monetary Fund in April 212 completed the seventh review of Sri Lanka's economic performance under a Stand-By Arrangement, and released a tranche of $42.9 million, bringing total disbursements under the arrangement to $2.13 billion. Fiscal Performance The government managed the fiscal balance well in 211. While total revenue and grants as a share of GDP decreased to 14. from 14.9 in the previous year, the expenditure dropped further to contain the budget deficit to 6.9 from 8. in 21 (Figure 11). Total revenue during 211 increased by 14.4 to Rs9 billion, of which tax revenue rose 12.1. Government expenditure was estimated at Rs1,4 billion, or 9.4 more than in 21. Recurrent expenditure rose moderately by 7.4 to Rs1,7 billion, reflecting government efforts to rationalize recurrent expenditures. Public investment secured a strong 14.3 increase and amounted to Rs47 billion. The overall fiscal deficit was Rs4 billion. Domestic sources financed 1 of the deficit, an increase from 4 in the previous year. Outstanding government debt declined to 78. of GDP from 81.9 in 21. In March 212, the government raised excise duties on motor vehicles, cigarettes, and liquor. With the revision, an excise duty of 14 7 was imposed on hybrid cars on top of taxes, making the overall tax and duty 6 12. The final tax and duties for regular petrol cars ranges 2 27 depending on the engine capacity. Excise duty on wine was increased by Rs6 to Rs838 a liter, hard alcohol by Rs6 a liter to Rs983, and other foreign alcohol types by Rs6 to Rs1,123. Duty on cigars, cheroots, and cigarillos containing tobacco was raised to Rs, from Rs4,37 per kg net weight. Figure 9 8 7 6 4 3 2 1 From Western Europe Tourist Arrivals 211 212 Total Source: Tourist Board of Sri Lanka Figure 1 Gross Official Reserves and Foreign Exchange Rate 9 8 7 6 4 3 2 1 Source: Central Bank of Sri Lanka. Figure 11 of GDP 2 1 1 - -1 Total Revenue 211 212 Gross Official Reserves ($ biilion, left axis) Rs/$ (right axis) Fiscal Balance Recurrent Expenditure Public Invesment 21 211 Other 13 13 12 12 11 11 1 1 Source: Ministry of Finance and Planning. 9 Overrall fiscal balance

6 Sri Lanka Quarterly Economic Update End Note 1 Suppose the price index increases by. monthly (6.2 annually), and there was a one-time price shock of in February 212 (Figure 12). Under these assumptions, year-on-year inflation increases from 6.2 to 1.9 for the next one year (February 212 to January 213), although the price shock occurred only in February 212. Month-to-month inflation, on the other hand, jumped from. to. only in the month of price shock, and went back to. the next month. 2 X-12-ARIMA is used to generate the seasonally adjusted CCPI series (with a base year of 26/7. Figure 12 Year-on-year and month-to-month inflation (example) Index 12 11 11 1 1 9 9 211 212 Index (left) Year-on-year inflation (right) Month-to-month inflation (right) 12 1 8 6 4 2 month-to-month/ Year-on-year inflation Source: ADB Staff

Sri Lanka Quarterly Economic Update The Quarterly Economic Update (QEU) provides a comprehensive and updated analysis of recent economic performance in Sri Lanka. The QEU for April 212 highlights balancing between inflation and economic growth, given that external demand is slowing down, and that year-on-year inflation will be high because of supply side factor. Slow growth will decrease fiscal revenue, and the government may face a dilemma between maintaining the level of capital investment and containing fiscal deficit. About the Asian Development Bank ADB s vision is an Asia and Pacific region free of poverty. Its mission is to help its developing member countries reduce poverty and improve the quality of life of their people. Despite the region s many successes, it remains home to two-thirds of the world s poor: 1.8 billion people who live on less than $2 a day, with 93 million struggling on less than $1.2 a day. ADB is committed to reducing poverty through inclusive economic growth, environmentally sustainable growth, and regional integration. Based in Manila, ADB is owned by 67 members, including 48 from the region. Its main instruments for helping its developing member countries are policy dialogue, loans, equity investments, guarantees, grants, and technical assistance. Asian Development Bank 6 ADB Avenue, Mandaluyong City 1 Metro Manila, Philippines www.adb.org Printed on recycled paper 9 78929 927648 Printed in the Philippines