VZCZCXRO8434
RR RUEHLMC
DE RUEHLM #0392/01 0930653
ZNR UUUUU ZZH
R 030653Z APR 09
FM AMEMBASSY COLOMBO
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RUEHCG/AMCONSUL CHENNAI 9156
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UNCLAS SECTION 01 OF 02 COLOMBO 000392 
 
SENSITIVE 
 
SIPDIS 
 
STATE FOR SCA/INS, EEB/IFD/ODF, and EEB/IFD/OMA 
STATE PLS PASS TO USTR 
 
E.O 12958: N/A 
TAGS: ECON EINV EFIN KMCA CE
SUBJECT: SRI LANKA: GDP GROWS BY 6% in 2008, BUT PROSPECTS ARE 
WEAKENING 
 
REF: (a) COLOMBO 215 
(b) COLOMBO 67 
(c) COLOMBO 22 
(d) 08 COLOMBO 1123 
(e) 08 COLOMBO 1113 
(f) 08 Colombo 1075 
 
¶1. (U) Summary:  The Sri Lankan economy grew by a healthy 6% in 
2008, despite the fourth quarter global economic slowdown, the 
escalated conflict in the north, and terrorist attacks elsewhere. 
Total GDP was $40.1 billion.  This translates into a per capita 
income of $2,014.  Inflation surged to 28% in June, but ended the 
year at 14.4%.  Prospects for 2009 are weakening.  Initial Central 
Bank (CB) forecast 2009 growth to be around 5-6%; that will be 
unattainable.  Fitch and EIU estimate growth will slow to 3%.  End 
summary. 
 
GDP UP 6% IN 2008 
----------------- 
 
¶2. (U) According to the Department of Census and Statistics (DCS), 
the Sri Lankan economy grew by 6% in 2008.  Growth fell short of the 
7% growth forecasted at the beginning of the year. Nevertheless, 
2008 growth once again demonstrated the economy's continued 
resilience despite the civil conflict.  Total GDP was $40.1 billion. 
 Per capita income (in US dollars) was up 23% to $2,014 in 2008 from 
$1,634 in 2007.  A Central Bank official attributed the rapid rise 
in per capita income partly to the inflationary impact on growth. 
The stability of the rupee (it depreciated by only 4% while 
inflation was high) and the low population growth were other 
factors.  According to these statistics, Sri Lanka's total GDP 
doubled within 4 years, and per capita income doubled within 5 
years. 
 
¶3. (U) Inflation (year on year) which was 18.8% in 2007 peaked at 
28.2% in June 2008.  Inflation was driven by government expenditures 
and high global oil and commodity prices.  In response to these 
forces, the Central Bank followed a tight monetary policy.  As a 
result, and due to decline in world prices for oil and commodities, 
inflation slowed to 14.4% in December 2008.  According to the latest 
statistics, inflation has continued to slow, dropping to 5.3% in 
March. 
 
¶4. (U) All three major economic sectors contributed to growth in 
¶2008.  Agriculture, which contributed about 13% of GDP, was the main 
driver of growth, with a strong 7.5% increase.  Paddy (rice) sector 
grew by over 22%, reflecting the inclusion of more than 133,000 new 
hectares of cultivated land in the Eastern Province; total paddy 
production in the three districts in the Eastern Province increased 
by 27%.  Other agricultural produce and livestock from the Eastern 
Province also recovered.  Tea, rubber and coconut production 
increased and prices reached record levels during the first three 
quarters due to increased world commodity prices.  However, with the 
spread of global financial problems these export commodities slumped 
in the fourth quarter.  Services, which account for about 57% of 
GDP, grew by 5.6%, the slowest growth in 6 years.  Telecom sector 
continued its strong growth, with a 22% increase.  Tourist arrivals 
recorded an 11% decline, a direct result of the escalated conflict. 
The manufacturing sector (including apparel), which accounts for 
about 18% of GDP, grew by 4.9%.  The construction sector which 
accounts for about 7.5% of GDP by grew by 7.8%. 
 
¶5. (U) External Sector:  Imports increased a staggering 24% to $14 
billion, mainly due to higher oil and commodity prices.  Exports 
also increased, albeit more slowly, by 6% to $8.1 billion.  As a 
result, Sri Lanka's trade deficit increased 60% to $5.8 billion in 
¶2008.  Remittances from Sri Lankans working abroad amounting to $2.9 
billion helped to partly offset the trade deficit and remained a 
source of resilience of the Sri Lankan economy.  Tourism continued 
to suffer due to the security situation.  While Sri Lanka's exposure 
to the global financial crisis was limited due to controls on its 
capital account, Sri Lanka experienced capital flight in 2008 by 
foreign investors who had invested in government debt instruments. 
The Central Bank's intervention to maintain a de facto peg at a cost 
of USD 2 billion saw Central Bank reserves decline to $1.7 billion, 
or 1.5 months of imports, by December 2008.  The rupee was allowed 
 
COLOMBO 00000392  002 OF 002 
 
 
to depreciate marginally in late December.  Overall in 2008, the 
rupee depreciated by only about 4% against the dollar and 
appreciated against most other currencies.  The appreciation of the 
real exchange rate has damaged export competitiveness. 
 
PROSPECTS FOR 2009 WEAKENING 
----------------------------- 
 
¶6. (U) In January, the Central Bank's initial forecast was 5-5.5% 
GDP growth in 2008, which, it underscored, would likely rise to 6% 
in response to various government economic stimulus packages. 
However, government claims to the contrary aside, signs of an 
economic slowdown are becoming evident.  Growth slowed to 4.3% in 
the fourth quarter of 2008, from 7.6% in 4Q2007.  Exports have 
slowed.  Exports fell sharply by 12% in January on top of a 19% fall 
in December.  It will be difficult to repeat the robust performance 
of agriculture seen in 2008, as agricultural exports are facing 
uncertain times.  Tea production declined by over 40% in the first 
two months of 2009 due to drought and lower application of 
fertilizer.  Although tea prices recovered in March from a large dip 
late last year, no one in the industry expects to match last year's 
revenue.  Rubber is suffering from both low production and low 
prices.  The effects of the global economic and financial crises are 
being felt in the industrial and services sectors.  In January, 
total industrial exports declined by over 5%.  Non-apparel 
manufactured exports such as ceramics, leather, and rubber products 
declined by over 12%.  The services, export/import trade, ports, 
construction, banking, real estate and tourism sectors are all 
vulnerable to global recession and domestic financial sector 
problems, and growth prospects for the year are weak.  Apparel 
exports, expected to decline, increased by 4.5%, but it will be 
difficult to sustain or increase this throughout the year.  On 
February 27, Fitch ratings said it "expects GDP growth to slow to 
only 3% in 2009, consistent with recessionary conditions in advanced 
economies and other emerging markets."  EIU also forecasts GDP 
growth around 3%.  Other analysts privately tell post that growth 
may ultimately be as low as 2.25%.  ADB's forecast for Sri Lanka is 
more optimistic at 4.5%, as it expects the imminent end to the civil 
conflict to pave the way for reconstruction if financing is 
available, giving a stimulus to the economy. 
 
¶7. (U) In a bid to stimulate growth, the Central Bank has lowered 
interest rates.  Statutory reserve ratios of commercial banks have 
also been significantly reduced.  However, lending rates charged by 
commercial banks remain high with the prime lending rate running 
over 18.65%.  Investment analysts say that lower rates are essential 
to boost growth.  In addition, although government has provided 
various stimulus packages (refs a and c) there are complaints that 
implementation is slow.  On March 20, Central Bank in a press 
release noted that "lending has declined sharply."  It urged banks 
to enhance lending so that "credit flow to the private sector is 
ensured and economic activities in the country are supported, 
thereby arresting any adverse consequences on the economy." 
Financial sector liquidity and lending have been affected by slowing 
exports, loss of confidence, as well as fraud and mismanagement in a 
popular local credit card company and numerous financial companies 
connected to it. 
 
COMMENT 
--------- 
 
¶8. (SBU) The Central Bank -- and its publicly released numbers -- 
remains very positive about Sri Lanka's and, more specifically, its 
own performance throughout 2008.  Although its actions to reduce 
inflation may be considered admirable by some, the fact that the 
country is in negotiations for an IMF Stand-by facility indicates a 
lack of appropriate fiscal policies and government expenditure 
restraint.  The CB's 2008 report, already overdue for release, is 
expected to include a revised forecast of projections for 2009.