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UNCLAS SECTION 01 OF 03 COLOMBO 000366 
 
SIPDIS 
 
SENSITIVE 
 
SIPDIS 
 
STATE FOR SCA/INS AND EEB/IFD/ODF 
STATE PLS PASS TO USTR 
 
E.O. 12958: N/A 
TAGS: ECON EINV EFIN KMCA CE
SUBJECT: SRI LANKA: 2007 GDP GROWTH REPORTEDLY 6.8%; FITCH 
DOWNGRADES SOVEREIGN CREDIT RATING 
 
REF: A. 07 COLOMBO 536  B. 07 COLOMBO 1305  C. COLOMBO 120 
 
¶1. (SBU) Summary: Sri Lanka continued its healthy economic growth in 
2007, reporting a 6.8% increase in real gross domestic product for 
the year.  Weaknesses in the government's statistical methodology 
suggest the actual growth figure may have been lower, probably 
closer to 6%.  The reported outcome was below the 7.5% the 
government had projected going into the year, but exceeded the Asian 
Development Bank (ADB) expectation that renewed war would bring 
growth down to 6%.  Total GDP was $32 billion, yielding per capita 
income of about $1,600.  For 2008, the Central Bank of Sri Lanka 
forecasts growth to be around 7%, whereas the ADB once again expects 
6%.  On April 2, Fitch Ratings downgraded Sri Lanka's sovereign 
credit rating from BB- to B+, citing increased risk from inflation, 
budget deficit, and worsened terms of trade arising from soaring oil 
prices.  The Fitch downgrade reflects the fact that, despite the 
economy's overall resilience to the conflict, it has very little 
leeway to weather a global economic downturn that could hit exports, 
bring down remittances, and dry up the external credit that has 
helped the government finance its chronic deficits.  End summary. 
 
GDP REPORTEDLY UP 6.8% IN 2007... 
--------------------------------- 
 
¶2. (U) On March 28, Sri Lanka's Department of Census and Statistics 
(DCS) released gross domestic product and other macroeconomic data 
for 2007 showing that Sri Lanka's economy grew by 6.8% in 2007. 
Though down nearly 1% from the revised 2006 GDP growth figure of 
7.7%, the 2007 result demonstrated the economy's continued 
resilience to the ongoing civil conflict.  Total GDP was $32 
billion, bringing per capita income up by 14% to $1,600.  The 
Central Bank noted that this outcome marked the first time Sri Lanka 
has recorded GDP growth above 6% for three straight years. 
 
... BUT MAY HAVE BEEN CLOSER TO 6% 
---------------------------------- 
 
¶3. (SBU) The DCS statistics are not wholly reliable, as the 
department uses unsophisticated data collection methodology and as a 
result has to fill in many blanks with guesses.  With the government 
regularly announcing unrealistically ambitious growth targets, and 
defensively lashing out when outside observers suggest that the 
economy is not performing as well as the government claims, there is 
pressure for DCS to embellish its numbers.  Until mid-2007, the more 
competent Central Bank produced Sri Lanka's GDP calculations, based 
on DCS surveys of economic activity combined with data from other 
sources such as industry bodies.  A few years ago, DCS began 
releasing its own calculation of GDP figures; DCS figures routinely 
came in a few tenths of a percent higher than the Central Bank 
numbers.  For example, for 2006, DCS reckoned GDP growth at 7.7%, 
whereas the Central Bank stated it was 7.4%.  (Note: Ref A cited the 
Central Bank figures, which we believed were more accurate.)  When 
the Central Bank stopped releasing its own GDP figures in 2007, it 
told us it had done so because it considered the DCS figures 
accurate and having two sets of figures was confusing. 
 
¶4. (SBU) We have heard from multilateral development bank contacts 
who have worked with DCS that its statistical methodology is 
"outdated and simplistic" and that its task is further compromised 
by poor private sector responsiveness to DCS's economic surveys. 
This contact cited the fisheries sector as an example: DCS is unable 
to actually track how many fish of what value are caught, so it 
relies on indicators like the increase in the number of fishing 
boats and an imputed increase in productivity to infer a quantity of 
growth in the sector.  Similarly, a former Central Bank statistician 
recently wrote in an English-language newspaper that she had noted 
to DCS seemingly inconsistent figures that the agency had difficulty 
explaining.  She cited a reported 9% growth rate in the construction 
sector despite a decline in cement availability and a reported 7.8% 
growth in domestic trade even though all categories of domestically 
traded goods recorded growth below 7%. 
 
¶5. (SBU) Post also noted some unlikely numbers in the DCS results 
for 2007.  For the first half of the year, DCS reported an annual 
GDP growth rate 6.2% (ref B).  For the second half, it reported that 
the economy grew at a rate of 7.3%.  DCS reported growth of 7.6% for 
 
COLOMBO 00000366  002 OF 003 
 
 
the fourth quarter, reporting double digit growth in the tea, 
fisheries, hotels, communications, banking, and finance sectors. 
These second half and fourth quarter figures strike us as 
implausibly high. 
 
¶6. (SBU) For the record, since the DCS figures are probably still 
fairly accurate for comparative purposes, the following are the 
sectoral breakdowns reported for 2007:  Services and  manufacturing 
were the main drivers to growth.  Services, which account for about 
two thirds of GDP, grew by 7.1%.  Within services, the main 
contributors to growth were import/export trade, retail trade, port 
services, telecommunications, and finance.  Tourism recorded a 12% 
decline, a direct result of the escalated conflict (ref C).  The 
manufacturing sector (including apparel), which accounts for about 
19% of GDP, grew by 6.4%.  Agriculture, which contributes about a 
tenth of GDP, was up 3.3%.  Rice, the staple cereal, declined after 
two years of record growth.  Tea production declined, yet had record 
earnings due to higher global prices.  Rubber production increased 
and benefited from high global prices. 
 
PROSPECTS FOR 2008: THE SAME 6-7% RANGE 
--------------------------------------- 
 
¶7. (SBU) The Central Bank forecast 7% growth in the Financial and 
Monetary Sector Road Map it released in January 2008.  The Asian 
Development Bank, in its recent 2008 Asian Development Outlook, 
predicted the Sri Lankan economy in 2008 would grow by 6%.  The ADB 
expects growth to be held back by a slowdown in private sector 
investment, weakening performance of the garment sector, and higher 
oil prices.  The ADB cited the economic slowdown in the United 
States and the EU and escalation in the conflict as added downside 
risks to economic growth.  Weather has also begun to look like a 
limiting factor for 2008 growth.  Heavy rains have caused floods 
that appear to have damaged 15-30% of Sri Lanka's rice crop. 
 
FITCH SOVEREIGN CREDIT RATING DOWNGRADE 
REFLECTS INFLATION, BUDGET AND TRADE DEFICITS 
--------------------------------------------- -- 
 
¶8. (U) On April 2, Fitch Ratings downgraded Sri Lanka's sovereign 
credit rating from BB- to B+, four tiers below "investment grade." 
It cited Sri Lanka's "increased vulnerability...to adverse shocks 
associated with rising inflation, persistently large fiscal deficits 
and worsened terms of trade due to soaring oil prices in the context 
of greater government recourse to commercial and market-based 
financing."  Fitch stated "increases in inflation and domestic 
interest rates have led to greater foreign-currency borrowing by the 
government."  (Note: Although Sri Lanka's overall debt-to-GDP ratio 
declined slightly in 2007 to 85.8%, its external debt load increased 
from 43.4% to 44.1% of GDP.)  Fitch noted that repayments on foreign 
currency debt in 2008 will amount to $1.5 billion.  Despite the 
Central Bank's tighter monetary policy, Fitch "expects inflation to 
remain relatively high, and...believes it will prove challenging to 
reduce inflation significantly without inducing a sharp slowdown in 
economic growth that would expose weaknesses in public finances." 
Like the ADB, Fitch judged "a lasting and secure settlement of the 
conflict is unlikely to be realized in the near term, and the risk 
of disruptive terrorist attacks, despite the military gains made 
against the LTTE, cannot be wholly discounted.  Moreover, with the 
management of the conflict being the overriding priority of the 
President and government, fiscal reforms and other economic policy 
issues are accorded less attention." 
 
¶9. (SBU) The Central Bank in a press release dismissed Fitch's 
concerns, as it did when Standard & Poor's not long ago downgraded 
its sovereign credit rating outlook for Sri Lanka to "negative." 
The Central Bank stated that reserves, remittances, and foreign 
direct investment would be more than sufficient to cover the 
country's debt service.  A New York-based securities analyst who 
follows Sri Lankan debt told Econoff that the Fitch downgrade would 
perhaps add a little to the cost of Sri Lankan debt, which currently 
yields over 10%, but was likely already mostly factored in.  He 
noted though that some institutional investors would have to stay 
away from the debt at the new lower grade because their investment 
guidelines would limit how far below investment grade they can go. 
 
 
COLOMBO 00000366  003 OF 003 
 
 
 
COMMENT: GROWTH IS REAL, BUT WITH PEACE 
WOULD BE HIGHER AND BETTER DISTRIBUTED 
--------------------------------------- 
 
¶10. (SBU) While the government may have yielded to the temptation to 
pad its GDP growth statistics in the absence of solid data, a look 
around the capital, the thriving Western Province, and even the 
formerly sleepy Southern Province shows that the economy continues 
its remarkable resilience in the face of the conflict and the 
Rajapaksa government's anti-private sector bias.  Cargo ships are 
lined up into and out of Colombo Port.  Tall buildings are going up 
around Colombo.  Road, rail, and port construction is underway in 
the South.  Shoppers are in the markets, new cars are on the 
streets, and investors are looking at projects from renewable energy 
to domestic aviation.  The shame is only that conflict has 
restricted this relative prosperity to only the West and the South. 
If the rest of the country was peaceful and growing at comparable 
rates, overall growth would easily hit the 8% level Sri Lanka needs 
to make real progress against its remaining poverty. 
BLAKE