A Mixed Bag for 1997

Sri Lanka's economy in 1996 was pounded by soaring defence spending, power cuts and political unrest. Why, then, are the planners bullish about the coming year.

Planners in Colombo´s Central Bank say that the Sri Lankan economy should rebound in 1997. They are pinning their hopes on recent victories scored against the Tamil rebels on the ground coupled with less capital expenditure anticipated for defence, and a general improvement in investor and market sentiments. According to R.A. Jayatissa, head of the Bank´s economic research unit, the inflation rate, GDP growth and the balance of payments will require close scrutiny in the months ahead. "Our primary target is to achieve sustainable GDP growth of at least seven percent from 1998 onwards and contain inflation to about six percent."

To do that, the country´ must achieve intermediate targets, such as money supply growth of about 16 percent, compared to the current 12 percent, and reduce the budget deficit to 7.3 percent of GDP in 1997. GDP growth is expected to dip to about 4 percent in 1996, down from 5.5 percent in 1995 and 5.6 percent in 1994.

The budget deficit in 1996 is thought to have been just below nine percent of GDP, compared to 8.4 percent in the year previous. Annualised inflation in 1996 stood at 15.9 percent. Mr Jayatissa says the ratio of investment to GDP this year will have to rise to 30 percent from 24.5 percent last year, with the majority coming from the private sector.

The Central Bank believes inflation could be slowed, despite a recent easing of monetary policy, because industrial production and agricultural output were expected to rise. The Bank relaxed monetary policy earlier this month by cutting statutory reserves and allowing exporters foreign currency borrowings. The Bank´s commitment to low rates is evident from the benchmark one year Treasury Bill yield, which fell from 19.05 percent in January 1996 to 15.28 at the end of the month. In January, the Bank also cut its overnight repurchase rate to 11.50 percent from 12.75 percent.

The wheat subsidy and drought-related power cuts are cited as the reasons for recent budgetary problems. Spending on wheat subsidies was cut in 1996 by raising the retail price of a kilogram of flour by five rupees (nine dollar cents) to 16.95 rupees (30 dollar cents). "Last year´s power cuts reduced company profits and was one of the main reasons for the market´s poor performance," says Rajiv Casiechitty, research manager at Colombo brokerage CT Smith.

The threat of power cuts, indeed, is very much in the minds of investors as they look ahead to 1997. More than 85 percent of Sri Lanka´s power needs are met by hydro-electricity generated by hydro reservoirs based in the hill country, which has seen little rain for the second year in a row.

Last year, Ceylon Electricity Board (CEB), the state power utility was forced to introduce daily eight-hour power cuts during the height of the drought, temporarily shutting out many of the island´s small and medium businesses and industries. The CEB says it seeks to increase its thermal power generation capacity to account for about 50 percent of total output, which would technically tide over the hydro shortage.

"Considering all this and conservative production estimates for 1997, we do not expect major slippages in the budget," says the Central Bank´s Jayatissa. But analysts warned that soaring defence spending, one of the main factors that hobbled the economy in 1996, may continue to be high this year too.

Defence spending in 1995 rose to 34 billion rupees (USD 629 million) from the budgeted figure of 24 billion (USD 444 million) as the government´s war with the separatist ltte got into high gear. Defence was the single biggest item of expenditure in the country in 1995 and the budgeted figure for 1996 is 38 billion rupees (USD 703 million). It is expected that around 44 billion rupees (USD 771 million) will be spent on arms in 1997.

However, analysts are not optimistic of the government keeping to this budgeted expenditure, not after the air force lost three planes (and one drone) during the first two months of this year. In this short span, an Antonov-32 transport, a Chinese-built Y-12 transport aircraft, and an Israeli-built Kfir fighter jet went down in various places.

Air Vice Marshall Anslem Peiris, the air force chief, said the loss of the aircraft, though great, would not be allowed to affect "the government´s strategy of militarily defeating the LTTE". But, a private sector analyst said: "Ours is a small air force and it is going to need new planes if it is to play its role in the government´s war plan. The bottom line is we will have to buy a few planes this year and they will be expensive."

While the government is losing money in the air, however, it is making gains on the ground against the rebels. The military made its latest breakthrough in the war on 21 February when it captured a key highway linking two northern towns, effectively limiting the rebels´ movements in an area which was once dominated by them.

"Each military gain makes the government look good and in control," says the analyst. "Basically, that is what makes an economy tick. It improves investor confidence." The Sri Lankan capital has not been disturbed by rebel attacks for nearly eight months and is seeing a gradual improvement in the mood as the war is confined to corners in the north and east.

However, "investor confidence" may still be clouded if next month´s local government elections turn violent, say observers. The 21 March polls, the first test of popularity for the ruling People´s Alliance since coming to power in September 1994, has already been marred by the killing of a young ruling party legislator. This was followed by two days of noting. As Mr Casiechitty says: "Elections are periods of violence, low productivity and damage to infrastructure."