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RR RUEHLMC
DE RUEHLM #0793/01 1360936
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R 160936Z MAY 06
FM AMEMBASSY COLOMBO
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UNCLAS SECTION 01 OF 02 COLOMBO 000793 
 
SIPDIS 
 
STATE SA/INS; MCC FOR D NASSIRY AND E BURKE 
 
SIPDIS, SENSITIVE 
 
E.O 12958: N/A 
TAGS: ECON CE
SUBJECT: Central Bank reports 6% GDP Growth Sri Lanka in 
¶2005. 
 
 
¶1. (U) Summary:  According to the Central Bank, Sri Lanka's 
economy grew by 6% in 2005 compared with 5.4% in 2004.  Post- 
tsunami reconstruction, debt moratoria and foreign grants 
 
SIPDIS 
and loans helped mitigate the adverse effects of the 
December 2004 tsunami.  Main contributors to growth were 
telecommunications, exports, construction, financial 
services and domestic agriculture.  Foreign remittances of 
USD 1.96 billion, mostly from Sri Lankan workers abroad, 
helped to partially offset a USD 2.5 billion trade deficit. 
While the budget deficit increased to 8.7% of GDP, there was 
a notable improvement in government revenue.  Inflation and 
monetary expansion was high, but began to ease towards year 
end.  The Government expects economic growth to accelerate 
to 6.9% in 2006. The Bank also highlighted the need for 
additional structural reforms to improve growth prospects. 
End Summary 
 
GDP growth 
 
¶2. (U) On April 27, the Central Bank released its 2005 
annual report and announced that Sri Lanka's economy grew by 
6% in 2005 - compared to 5.4% in 2004.  Total GDP was USD 23 
billion and per-capita income reached USD 1,197.  All three 
major sectors contributed to growth.  Services, the largest 
sector, accounted for 56% of the GDP, followed by industry 
(27%) and agriculture (agriculture, fisheries and forestry) 
(19%). 
 
¶3. (U)  The agriculture crop sub-sector (excluding fisheries 
and forestry), which had been a drag on overall growth in 
the recent past, bounced back strongly, growing by 8.8%, and 
was a positive contributor to growth in 2005.  Tea and rice 
production reached record levels -- Sri Lanka achieved self 
sufficiency in rice, helped by good weather and government 
assistance (through an expensive fertilizer subsidy).  Rice 
production accounts for about 3% of GDP.  Other non- 
plantation agricultural crops also improved and contributed 
8.5% of GDP.  In the industrial sector, the manufacturing 
sub-sector (including export industries) increased by 6%. 
Construction expanded by 8.9% due to an expansion in 
infrastructure and post-tsunami reconstruction.  Services 
grew by 6.4%.  Telecommunications has grown strongly by 27% 
and government services by 5.1%. While fisheries and tourism 
contracted sharply due to tsunami damage, their small 
contribution to GDP (less than 2% each), meant relatively 
little drag on growth. 
 
External Trade 
 
¶4. (U) On the external front, the trade deficit expanded by 
12% to USD 2.5 billion.  However, this was partially offset 
by strong growth in remittances.  Worker remittances were 
USD 1.9 billion and tsunami-related current remittances were 
USD 50 million.  As a result, the current account deficit 
held at USD 650 million or 2.8% of GDP. 
 
¶5. (U) Exports grew by 10.2% to USD 6.3 billion and imports 
by 10.8% to USD 8.9 billion in 2005.  The petroleum bill 
increased by 37% to USD 1.65 billion, and accounted for 
about 19% of the import bill.  Sri Lanka's oil import bill 
has doubled since 2003.  Sri Lanka's key garment exports 
increased by 3.1% and comprised 45.6% of overall exports. 
Tea, rubber products and food products also recorded higher 
growth rates.  The US was the largest export market, with a 
share of 31%. 
 
¶6. (U) Foreign grants and loans (including tsunami 
assistance) and debt moratoria helped to offset the current 
account deficit and the Balance of Payment recorded a 
surplus of USD 500 million.  Foreign Direct Investment 
inflow was USD 272 million.  Consequently, external reserves 
improved by 24%, to USD 4.2 billion, sufficient to cover 5.7 
months of imports. The debt service ratio was 6.3% (exports, 
services and remittances).  The rupee appreciated slightly 
in 2005. 
 
Government finances 
 
¶7. (U) Government fiscal performance has been mixed.  The 
government was unable to stick to fiscal targets and the 
budget deficit increased to 8.7% of GDP from 8.2% of GDP in 
 
COLOMBO 00000793  002 OF 002 
 
¶2005. 
 
¶2004.  Government expenditure rose due to tsunami-related 
expenses and a sharp rise in government expenses on 
subsidies and salaries (due to new hiring and wage 
increases).  According to the Central Bank, the government 
has spent about Rs 33 billion (USD 330 million) (1.4% of 
GDP) on oil and fertilizer subsidies in 2005 (additional to 
be settled bills still remain).  Total defense spending was 
Rs 82 billion (USD 820 million) (3.5% of GDP).  Public 
investment was 6.3 percent of GDP, including tsunami 
reconstruction expenditure of 1% of GDP. 
 
¶8. (U)  On the positive side, total revenue increased by 22% 
and amounted to 16.1% of GDP reversing a gradual decline in 
revenue seen since 1999.  Tax revenue increased by 20% to 
14.2% of GDP.  Total government debt stock has increased by 
Rs 82 billion (USD 820 million), but as a ratio of GDP it 
declined to 93.9% of GDP from 105% of GDP in 2004.  This was 
due to the appreciation of the rupee and the higher growth 
in nominal GDP. 
 
Inflation and monetary policy 
 
¶9. (U) Monetary expansion was high in 2005.  Average annual 
inflation was 12% in 2005, and interest rates remained below 
inflation.  Money supply grew by more than 20%.  Private 
sector credit grew by 21.5%.  In response, the government 
increased key policy rates on four occasions.  Together with 
improved supply conditions, inflation declined from a peak 
of 16% in February to 8% by December 2005, and showed signs 
of further weakening in the first quarter of 2006.  Monetary 
expansion also showed signs of slowing by the end of 2005. 
Interest rates remained below inflation in 2005. 
 
Economic outlook for 2006 
 
¶10. (SBU) According to the medium term macro economic 
framework included in the report, GDP growth is forecast to 
accelerate to 6.9% in 2006.  According to the Central Bank, 
a growth rate of over 8% is required to solve the problems 
of unemployment (running around 8%) and poverty on a 
sustainable basis.  The Central Bank noted growth will 
depend on restoring peace, inflationary control and slowing 
monetary expansion.  Inflation is expected to slow to 8% in 
2006 (though the Central Bank Director of Economic Research 
suggested to Econchief that he believes it will run at about 
10% most of the year).  Monetary expansion is targeted at 
15%, a rate that Sri Lanka agreed to target during an IMF 
visit in late 2005.  The bank also warned that high oil 
prices could cause problems to the Balance of Payments, 
government fiscal control, exchange rate management, 
inflation and further weaken the financial position of the 
related state utilities.  In order to mitigate oil price 
effects, the bank has urged the government to adjust prices, 
phase out subsidies and restructure energy related public 
institutions.  The Central Bank has also highlighted the 
need to take on structural reforms to improve public 
infrastructure, health and education and the efficiency of 
public institutions.  Further, the bank has identified the 
need to enlighten the general public of the benefits of free 
and liberal economic policies, structural reforms, 
competition, the cost of protection and subsidies and the 
role and limitations of the public sector. 
ENTWISTLE