5.8 percent growth forecast for 2008 – RAM Holdings

The Central Bank will have to continue with its tight monetary policy in order to curb domestic credit which led to high inflation (the highest in the region nearing 30 percent) by further raising interest rates, said Dr Yeah Kim Leng, Chief Economist, RAM Holdings Berhad yesterday.

Dr Leng expects the Central Bank to tighten interest rates by up to 75 basis points in the second half of the year.

"Expansion in demand for domestic credit is caused by excessive government spending to narrow down the fiscal deficit and by private sector spending," he said when RAM Holdings launched an economic outlook report titled "Sri Lanka: Key Economic Challenges and Prospects for 2008 and 2009 – Coping with External Shocks and Internal Challenges."

He pointed out that the high fiscal deficit (7.2 percent of GDP in 2007 which is expected to hover around 7 percent this year) was attributed to an increase in military and security spending, funding huge infrastructural and rural development projects and huge public sector wage costs while the current account deficit expanded on large oil, commodities and food export bills, a depreciation of the exchange rate and strong consumer demand.

The twin deficits led to persistently high levels of inflation, high interest rates, a volatile exchange rate and erosion in investor confidence and the government was urged to closely monitor the deficts.

Dr Leng recommended that private sector financing of infrastructure projects, privatisation, increased foreign direct investments, shifting into high value manufacturing and high wage services industry and increasing savings by broadening and deepening the banking system and capital markets are some of the policy measures the government ought to take to consolidate the fiscal deficit.

"By increasing foreign direct investments the government can finance its debt obligations which will leave room for the private sector to access domestic credit."

He said that having a healthy fiscal deficit was one way in which to escalate growth only if government spent well on development activities and stressed that a healthy current account deficit can be good if it is spent on more investment goods over consumption goods. The current deficit remains below 5 percent of GDP which is the prescribed limit in order to foster sustainable development.

"Sri Lanka needs to spend on machinery and investments to sustain the factory production capacities which are on the decline. While trying to curb its overspending, the government should invest more on education and health which will have multiplier effect on development."

According to the economic outlook report the agricultural sector is expected to grow by 3.6 percent this year and 4.3 percent in 2009 supported by buoyant exports of tea, rubber and related products which recorded 40 to 55 percent growth during the first quarter of the year.

It said that agriculture remained on a moderately declining trend which was consistent with the transformation of an agriculture-oriented economy to a manufacturing and services economy.

The Manufacturing sector is expected to grow by 5.7 percent this year and 5.4 percent in 2009.

"The output of the apparel industry remained strong in 2008 with a moderate rise in exports. Nonetheless this high profile industry’s growth may cool down in the medium term due to intensifying price competition from countries such as Vietnam and Bangladesh," the report said.


Leng said that Sri Lanka’s economy would be more resilient than expected with growth forecast at 5.8 percent in 2008 (down from 6.8 percent in 2007) and 6.1 percent in 2009 despite adverse global economic conditions and strong domestic demand.

He said that high double digit inflation remains a major threat but the anticipated widening of fiscal and budget deficits are expected to return to a declining trend once international food and oil price shocks subside as speculators expect.

The overvalued rupee is expected to depreciate by one to three percent based on a trade weighted basis during the year.

Sri Lanka’s painful fuel subsidy removal in 2006 saved the country 0.7 percent of GDP annually but further escalation in fuel prices and energy costs continue to pose a threat.

Crude oil is expected to increase by 34.3 percent this year to decline by 1 percent in 2009, while international commodity and food prices are expected to increase by 22.5 percent and 18.2 percent respectively during the year, then decline by 2.5 percent and 0.9 percent in 2009.