Macroeconomic situation in Sri Lanka


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Macroeconomic situation in Sri Lanka

  1. 1. TL 1070Economies’ Potential to Achieve Higher GrowthTargetsName: Thushan DharmawardanaIndex no : 101414GSubmission date: 17/10/2011
  2. 2. ContentsIntroduction page 1Current Macroeconomic Situation page 2Strengths and Weaknesses highlighted by economic indicators page 2Feasibility of 9 % growth ratepage 5Areas of Policy Focuspage 7Negative Implications of pursuing higher growth rate page 9IntroductionAfter the free trade agreement in 1975 Sri Lankan economy has faced with certain circumstancesthat affected negatively on the growth of the economy as a whole. Now Sri Lankan Economy isin a situation where it is potentially growing in leaps and bounces after the liberation fromterrorism. Considering the latest Central Bank Report Sri Lanka is having a prospective growthin all the 3 main sectors in Gross Domestic Product.101414G Page 1
  3. 3. Current Macroeconomic Situation 3500 3000 2500 Rs. Billions 2000 Agriculture 1500 Industry 1000 Services 500 0 2006 2007 2008 2009 2010 Year Figure 1Data Source: Central Bank ReportConsidering the above chart the Gross Domestic Product of Sri Lankan Economy has increasedover the last five years. The increment rate of GDP for the last year has increased significantlyover the last year. Sri Lanka is in an advantageous situation considering basic macroeconomicindicators likeinflation, unemployment and per capita income. According to the central banksources inflation and unemployment rate has now turned out to be a one figure value.It took SriLanka 55 years to reach a per capita income of US$ 1,000 and during the last four years it hasbeen doubled, which indicates a clear progress in Sri Lankan Economy.Adding to those aspects New York Times had said that Sri Lanka is the best place to visit in2010, Wall street Journal had said that Sri Lanka will be one of the top ten countries for growthin the coming years. These recommendations and predictions show how economicallyprospective Sri Lanka is considering the macro picture.Strengths and Weaknesses highlighted by economic indicatorsPursuing towards a higher growth rate Sri Lanka has some factors which thrusts and drags whichevolves in making up the final growth rate.Sri Lanka is an important fragment of the world economy because of its geographical situationtherefore it is considered as a transport hub. The constituted open economy remaining in thecountry also provides ample opportunities for the agricultural, industrial and services sectors to101414G Page 2
  4. 4. grow. Sri Lanka has the second highest literacy rate in South Asia which makes Sri Lankacompetent among the other economies. Nowadays English is widely used in urban an area that’salso a good sign towards a better Sri Lanka. According to Central bank sources Sri Lankatourism is also booming after the eradication of terrorism.Year Tourist arrivals 2005 549,308 2006 559,603 2007 494,008 2008 438,475 2009 447,890 2010 654,476Data Source: Sri Lanka Socio Economic Data – Central Bank of Sri LankaIn year 2010 tourism sector in Sri Lanka achieved a growth rate of 46.12 % which demonstratethe opportunities Sri Lankan citizens would have to involve in economic growth.Sri Lanka alsohas a booming and modern services sector. As shown in figure 1 the services sector has becomemore efficient.Tourism, banking, finance, and retail trade are the major components of theservice sector. Also IT industry has made some rapid progress over the past few years, becominga fountain of jobs for Sri Lankan youth.Apart from the above mentioned aspects there are some negative attributes attached to SriLankan Economy. Human capital is the most important resource for a nation to advance towardsa better position in world economy. Unfortunately ‘brain drain’ is a severe issue whichundermines human capital base.Loss incurring state owned enterprises, low public investment and high fiscal deficits deceleratesthe growth rates of economy.101414G Page 3
  5. 5. 90 80 70 60 % of GDP 50 Budget Deficit 40 30 Public Debt 20 10 0 2006 2007 2008 2009 2010 YearData Source: Central Bank Report Figure 2As shown in the above figure the budget deficit of the country is rotating around a samepercentage of GDP but there doesn’t seems an end of this cumulative debt public have to pay oneway or another. There is also a high regional inequality considering the growth of grossdomestic product. Mostly urban areas are obtaining the benefit of economic growth while otherareas don’t have the opportunity to acquire above mentioned efficient and quality services. Toflourish as a nation all regions should contribute with its fullest potential. Infrastructure deficitsin an economy such as roads, electricity makes the situation worse.year Road Kilometers New registration of motor vehicles 2005 11661 229669 2006 11773 300522 2007 11902 297892 2008 11902 265199 2009 11919 204075 2010 11923 359243Data Source: Sri Lanka Socio Economic Data – Central Bank of Sri LankaThe rate of new vehicles approaching roads has increased immensely while the transportationinfrastructure remains the same. Addition of motor vehicles assists congestion on roads thatwastes resources that could have been utilized for economic development.101414G Page 4
  6. 6. Feasibility of 9 % growth rateTo achieve the above mentioned target Sri Lankan economy has to overcome certain challenges.The employment levels should increase while getting rid of the budget deficit.Higherproductivity should be attained and investment should increase to obtain a growth rate of 9%ICOR * g = 1/YICOR – Incremental capital output ratiog – Growth rateY – Current GDPICOR value determines how much output a given amount of investment will bring. Consideringthe above formula to increase the growth rate of a country ICOR value should decrease.Normally in Sri Lanka ICOR value is about 5 while in USA is about 2.5. Figure 3 Source: John Diandas Memorial OrationA real growth rate of over 9% during the next five years will mean the Sri Lanka economyshould have a GDP around USD 120 Billion at current market prices and a per capita GDParound 4800. At the moment Sri Lanka is having an ICOR value of 4.5 therefore for a 9 %growth rate there should be an increase of about 40 % of GDP. If investors involve in more to theeconomy and with a lower ICOR value, increasing the capital stock productivity it is certainlyfeasible to achieve a growth rate of 9 %. Sri Lanka should focus on commercial agriculture and adynamic services sector. Improving productivity in main sectors of an economy is the key toaccelerate economic growth.101414G Page 5
  7. 7. Achieving a higher growth rate also derived by the educational level in a country but recently thegovernment expenditure on education has reduced significantly. It should be revised and moreand more investment on education should be done to have a sustainable long term economicgrowth. GDP increase 25 20 Incraes in GDP 15 10 5 GDP increase 0 2006-07 2007-08 2008-09 2009-10 periodFigure 4Data Source: Central Bank ReportAs shown in the above figure 23 % GDP increase has been achieved in 2007/2008 period in spiteof the civil war. Therefore with lots of business ventures coming up Sri Lankan economy cansurely have that 40% GDP increase needed in order to gain 9% growth rate.101414G Page 6
  8. 8. Areas of policy focusThere are some policies that can be implemented in achieving the growth targets. Even thoughthere are some negative aspects, privatization in my opinion is a good option. Throughprivatization productivity and efficiency will be increased and therefore productivity of capitalstock would increase and simultaneously ICOR value would also decrease.Government should consider on fiscal policy and taxation paying special attention to thedeclining trend of government revenue. The monetary policy also should be simple to understandmaking it feasible to short and medium term management of the economy. In other wordsinterest rates and tax rates should be manipulated transparently. 5000000 4500000 4000000 3500000 government revenue Rs.million 3000000 2500000 2000000 Total government 1500000 expenditure 1000000 Outstanding Government 500000 Debt 0 2006 2007 2008 2009 2010 YearFigure 5Data Source: Central Bank ReportAs shown in the figure outstanding government debt is increasing in a rapid rate thereforegovernment can’t take the risk of moving with Keynesian policy. Government should try toincrease their revenue while cutting down their expenditure through effective utilization of abovepolicies.PPI (Producer Price Index) and CPI (Consumer Price Index) are also important factorsconsidering the economy. These two aspects measure the inflation rate of a country. Inflationplays a key role in the economic growth that a small inflation rate can cause a larger reduction ofper capita income. Inflation also reduces the level of business investment and the efficiency with101414G Page 7
  9. 9. which productive factors are put to use.Therefore managing these indices are important inachieving the growth targets. 25 20 Precentage 15 10 inflation growth rate 5 0 2006 2007 2008 2009 2010 YearFigure 6Usually inflation and growth rate have a negative relationship but in year 2009 as shown in thegraph drastic decrease in inflation has occurred. The method of calculating inflation in year 2009is suspicious because calculation did not include some consumer goods. Nevertheless having alesser inflation rate is better considering the growth of an economy.Economic infrastructureinvestment raises productivity and lowers production costs. Investing in physical infrastructureenhances the private sector efficiency and growth.101414G Page 8
  10. 10. Negative Implications of pursuing higher growth rateRapid rate of growth might be at the expense of the current account of the balance of payments.When economy grows up the aggregate demand for goods also increases. In the normal scenariowhen more money hangs around people there occurs a propensity on imports more than exports.Therefore larger economic growth might construct larger trade deficits. However economicgrowth can be achieved without worsening the balance of payment in goods and services. Theexchange rate should be strong, therefore relative prices of goods coming to Sri Lankan economyfalls. Vice Versa price of export goods will rise. This will lead to a favourable balance of tradeand a higher growth rate.GDP of a country might rise but the benefits of the growth are not evenly distributed. This willlead to income and wealth inequality where it creates an enormous contradiction between therichest and the poorest elements of the population.At the same time there is a possibility of demand pull and cost push inflation in the long run ifdemand grows faster than anticipated .Higher inflation can lead to rise in interest rates and cancause a loss of competitiveness for local producers in the international market. 7,000 6,000 5,000 4,000 3,000 Population ( thousands ) 2,000 GDP ( Rs. Billions) 1,000 0Figure 7Considering the above graph highest GDP/Population ratio is from Western province whichindicates the inequality of sharing benefits of the booming economy.101414G Page 9
  11. 11. Fast growth of production and consumption can create negative externalities such as increasednoise and air pollution and road congestion. Environmental damage can have a negative effect onour quality of life and limits our sustainable rate of growth. Therefore focus should be on asustainable economic growth. To achieve this sustainable economic growth government shouldfollow a policy such as ‘Green Growth’ concept implemented in other Asia Pacific Countries.Therefore we have to consider on all those factors and have a strategic plan where the negativeimplications can be mitigated and achieve the expected growth target.101414G Page 10
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