III. ECONOMIC TRENDS AND OUTLOOK Major Trends and Outlook The economy has been growing at a pace of 4.5 to 6.9 percent over the past few years. Uncertainty over elections due in late 1994 have put a bit of a damper on growth, but increased government outlays will probably help to keep the growth rate in 1994 and 1995 in the 5 to 6 percent range. Textile exports are the leading growth sector. While there is some concern that the economy is becoming overly dependent upon garment manufacturing, the nation produces and exports only one-twentieth of the amount of garments that countries like South Korea and Taiwan export. Textiles are likely to remain the dominant industry for many years to come, but there are also increasing possibilities for the expansion of assembly industries, leading eventually to full production of such products as electrical home appliances, power tools, hardware, and perhaps data processing components and units. In addition, some value added might be gained in new agricultural export efforts; e.g., in bananas, pineapple, vanilla, other spices, and more processing of the traditional crops of tea, rubber and coconut. Americans should be aware that the current government is promoting private enterprise, privatizing state firms, and deregulating most industries. If the ruling party changes in the 1994 elections, there is guarded optimism that a new government would continue much along the same lines -- even though the opposition parties championed socialism in the past. Continuing issues of concern are unemployment (now around 12 percent), and how to resolve the insurrection in the distant north and east. Currently 4 to 6 percent of GDP goes into battling the insurgency, but its effects are little felt in the economic heartland of the country. In the longer term, manufacturing investments are likely to pay the greatest dividends to American businessmen. In the nearer term, America's best bets are to sell to and invest in infrastructure projects. In addition to heavy equipment for the power sector, road building, aircraft, ports, the railroad, and telecommunications, there will remain a vibrant market for U.S. computers, software and the like. Major Sectors The economy had remarkable performance in 1993 with real GDP growth of 6.9 percent. The agricultural sector, which accounts for 21 percent of the GDP, made a strong recovery, registering 4.9 percent growth. The manufacturing sector grew by 10.5 percent. The services sector grew 6.3 percent. The following table presents percentage changes in sectoral output over the preceding year, courtesy of the Central Bank: Sector 1992 1993 Agriculture, Forestry & Fishing 1.6 4.9 Mining & Quarrying -6.0 11.9 Manufacturing 8.8 10.5 Construction 8.1 6.5 Services 5.3 6.3 GDP 4.3 6.9 Agriculture: The agricultural sector bounced back in 1993. Production of rice, Sri Lanka's staple cereal, increased strongly from the drought-affected harvest of 1992, but remained about 3.5 percent below the peak level obtained in 1985. Both average yields per hectare and the acreage sown increased, as favorable weather prevailed throughout the year. In the plantation sector, tea production grew strongly to 232 million kilos in 1993. Recovering from the drought-hit crop of 1992, it registered a 30 percent increase, but fell short of the record-setting 241 million kilos harvested in 1991. Fertilizer usage increased by over 25 percent. The export price (FOB) of tea increased from $1.87 per kg to $1.90. Overall, the dollar value of tea export earnings increased by more than 20 percent in 1993. Rubber production increased marginally by 1 percent but coconut production declined due to lagged effects of the 1992 drought. Prospects for agriculture production in 1994 remain bright, with strong increases in tea, paddy and coconut production in the first half. Tea prices in June and July declined sharply. The government has intervened by providing concessionary financing for private tea factory owners and tea buyers. Manufacturing: With impressive expansion in production in recent years, manufacturing has become the main growth sector of the economy. Output in the sector increased by a strong 14 percent, with the bulk of the increase coming from private enterprise. When the output of the oil refinery is excluded, the expansion in output was around 12 percent. The government-owned companies, which constitute about one eighth of total industrial production, also recorded an increase of 20 percent. Output of textiles and garments, which grew by 31 percent in 1992, grew at a slower pace of 17 percent in 1993. Other industrial categories showing substantial increases were the chemicals, petroleum, rubber and plastics sector (25 percent), paper products (18 percent), wood products (18 percent) and processed foods (7 percent). Basic metals and fabricated metal products recorded decreases in output. Services: Performance in the services sector continued to improve, recording a 6.3 percent increase in 1993. Significant growth in trade, finance and utilities helped to boost the services sector. Wholesale and retail trade grew by 8.3 percent. Earnings from the rapidly expanding financial services sector were very robust. Hydro power generation increased by 31 percent with increased rain. However, the tourist industry failed to fare as expected as tourist arrivals declined in the second quarter of 1993. Government Role in the Economy Under the current United National Party government, Sri Lanka continues to discard socialist/statist economic practices and is moving forward with market reforms. The government has deregulated most sectors, eliminated most price and quota controls, liberalized the issuance of import licenses, terminated export taxes, privatized many state-run firms, and it actively promotes inward investment in almost all fields. There are no exchange controls on current account transactions, the modernized stock exchange is open to foreign investors, and the country has applied for Article VIII status with the IMF. Nonetheless, the government remains a significant factor. All infrastructure (roads, water, phones, rail and electricity) is still owned by the government, as are the petroleum corporation, the two largest banks, two insurance companies, the airline, shipping line, and many other companies. Decisions on tenders called by any government body or state enterprise are frequently vetted and argued by the Cabinet, and the government still controls the price of bread, petroleum products, electricity, water and telephone service. As the government seeks to reduce its role in the economy, however, it is experiencing problems with macroeconomic management. Budgetary Performance: The budget deficit before aid grants in 1993 increased marginally to 8.1 percent of GDP. Current expenditure grew by 12.6 percent to Rs. 100 billion and accounted for 75 percent of total expenditure. Current expenditure in relation to GDP declined from 21.1 percent in 1992 to 20.3 percent in 1993. Public investment funded through the budget increased to Rs 39 billion, equivalent to 8 percent of GDP. Revenue grew by 14.8 percent. Interest payments on government debt formed 28.6 percent of current expenditure. Total official debt rose to 483 billion rupees ($10 million), equivalent to 97 percent of GDP. The following table presents government fiscal operations as a percentage of GDP. 1993 figures are provisional and 1994 figures are projections: Government Accounts 1992 1993 1994 Revenue 20.2 19.8 20.3 Expenditure and net lending (a) 27.5 27.9 27.1 Defense 4.3 4.2 3.7 Deficit before grants 7.3 8.1 6.8 Domestic Finance (net) 3.7 4.5 2.2 Foreign Grants and Loans (net) 3.6 3.6 4.6 Debt Service 12.2 11.3 10.8 (a) Excludes repayment of public debt In 1993 government sector employment increased due to recruitment of teachers (11,580) and health personnel (2,440). Semi-government employment decreased due to transfer of public corporations to the private sector under the privatization program. The expenditure on government sector salaries and wages rose by 25 percent in 1993 due to a substantial wage increase. The government also unilaterally increased salaries for plantation and garment workers despite strong protests by management. Government Employees in '000 1989 1991 1992 1993 Central, Provincial and Local Government 588.5 652.6 653.9 676.5 Semi-Government 749.7 654.4 637.3 618.8 Total 1,338.2 1,307.0 1,291.2 1,295.3 Share of Workforce(pct) NA 25.7 25.0 24.8 Privatization: Since 1989 approximately 40 state enterprises have been privatized, including 12 during 1993. The total value of the first 11 firms sold in 1993 was just over Rs 2 billion ($40 million). The 12th company, the Puttalam cement plant, was sold for an additional Rs 2 billion in late December. There are plans to privatize an additional 47 firms in the 1994-95 time frame. Balance of Payments Situation The merchandise trade deficit in 1993 expanded by 10 percent to $1,150 million. The current account deficit meanwhile, shrank by 10 percent to $366 million, as the services account recorded a $42 million surplus for the first time since 1982. The transfer account surplus also increased by 12 percent to $722 million. Even more encouraging, the basic balance leaped ahead from a 1992 surplus of $103 million to $462 million in 1993. This occurred as 1993 private sector net capital inflows totalled $587 million, versus $273 million in 1992. Government net long-term inflows remained nearly constant at $261 million. In 1993 Sri Lanka's merchandise exports rose 16.4 percent to $2,864 million, while imports increased at a slower pace of 14.5 percent to $4,011 million. Export growth was fuelled by rising industrial (manufactured) exports and a recovery in tea exports. Industrial exports grew 19 percent, accounting for 73 percent of total exports. Textiles and garments, which account for almost half of Sri Lanka's gross export earnings, recorded a growth of 16.3 percent. Other non-textile industrial exports grew even more strongly, by 25 percent, reflecting further diversification of the export base. With the return of good weather, tea exports recovered in 1993 recording 21 percent growth. Earnings from other plantation products, however, declined by 2 percent. Minor agricultural crops (fruits, vegetables and spices) increased by 7 percent. Overall, agricultural exports increased by 8.4 percent. Meanwhile, mineral exports increased by 21 percent. Imports of investment goods recorded the strongest growth (23 percent) rising by $196 million. This was partly due to the purchase of two airbuses ($87 million). At the same time, intermediate goods grew by 14.5 percent, while consumer goods were relatively flat, with 6.2 percent growth. Significantly, imports of machinery and equipment recorded an increase of 19 percent, a strong indication of healthy prospects for further economic expansion. Imports of foodstuffs, especially rice, dramatically declined in 1993, as more favorable weather prevailed throughout the year. Imports of non-food consumer items increased by 14 percent. In the intermediate goods category, textiles remained the largest single import and rose 13 percent to $865 million, in line with a 15 percent rise in apparel exports. Imports of fertilizer and chemical products increased by 19 and 15 percent respectively. The following table presents major imports and exports for 1993. All figures are in millions of dollars, and are courtesy of the Central Bank. 1993 Exports 1993 Imports Textiles & apparel 1412 Textiles 865 Tea 413 Machinery & equip. 464 Minor agricul. prod. 121 Transport equipment 311 Petroleum products 79 Petroleum 309 Gems 71 Building materials 194 Rubber 64 Wheat & wheat flour 127 Food and beverages 63 Sugar 116 Coconut 58 Chemicals 109 Other 583 Other 1516 Total exports 2864 Total imports 4011 Japan continued to be Sri Lanka's largest supplier, as imports from Japan increased by 8.9 percent to $453 million in 1993. Japan's share of the Sri Lankan market was 11.3 percent. India maintained her position as the second largest supplier (8.6 percent) followed by the East Asian economies of Taiwan, Hong Kong, South Korea and Singapore which together accounted for 25 percent of the market. Imports from the United States increased by 14 percent to $203 million, but the U.S. share of the import market remained unchanged at 5.0 percent. Over half ($106 million) of U.S. exports to Sri Lanka consisted of wheat. Other exports from the U.S. included aircraft parts, rubberized fabrics, printing machinery, antennas, insecticides, agro chemicals, radio transmission equipment, cellular phones, telephone switching equipment, computers, paper, printed matter, and gloves. On the other side of the ledger, the United States continued to be Sri Lanka's largest export market, taking over a third of the total. Exports to the U.S. in 1993 increased 20 percent to $1,008 million. Apparel comprised over 80 percent of all such exports, totaling $815 million. Western Europe as a whole absorbed about $925 mn or 32 percent of the total; just a bit less than the United States. Debt Service: Sri Lanka's debt service payments recorded a $44 million decrease in 1993, due to a reduction in both interest and amortization payments. The rates of debt service to export proceeds also dropped as export revenues rose. The debt services ratio decreased remarkably from 17.1 percent of earnings from exports and services in 1992 to 13.7 percent in 1993. When private remittances are factored in, the debt service ratio declines further to 11.7 percent. Sri Lanka's loan profile is undergoing a major change, as commercial loans obtained in the early eighties are being repaid and soft loans from international donors are rising proportionately. Sri Lanka's gross foreign exchange reserves improved markedly in 1993, rising by 47 percent to $2,119 million, sufficient to finance over 6.5 months of imports. Exchange Rates: The rupee continued to depreciate against the dollar (7.2 percent) and other major currencies last year. When inflation differentials are taken into account, Sri Lanka's currency appreciated in real terms, however, by a weighted average of 0.3 percent against its major trading partners. Foreign Investment: The flow of inward foreign direct investment rose 56 percent from $121 million in 1992 to $189 million in 1993. In addition $68 million came through the local stock exchange as portfolio investment. In 1993, the government approved 455 foreign investment projects and 323 agreements were signed. The foreign investment potential of these was over $400 million. From January to April, 1994, 122 projects were approved and 117 agreements signed. Foreign Assistance: In 1993, Sri Lanka received over $600 million in gross foreign assistance, equivalent to approximately 5.8 percent of GDP. Actual net inflows were $460 million. The Asian Development Bank, World Bank, IMF, the Japanese and the U.S. were the largest donors. The U.S. assistance delivered over the period 1990-1993 amounted to $275 million. In 1994, the U.S. government has obligated $47 million. Trade and Investment Barriers Sri Lanka is increasingly open to foreign trade and actively seeks foreign investment. It first opened its doors to foreign competition in 1978, ahead of most other South Asian countries. Early this year, Sri Lanka applied for Article VIII status with the IMF as it lifted all remaining exchange control restrictions pertaining to current account transactions. That step has further enhanced its trade and investment climate. Sri Lanka has adopted a 4-band import tariff schedule (10, 20, 35 and 45 percent). Most finished consumer goods and agricultural products are taxed at 50 percent. With a few exceptions, raw materials and industrial inputs are taxed at 10 percent. Textiles (50 percent) and cars (50 to 100 percent) do not come under the 4-band tariff. Imports for export-oriented industry, however, are either entered duty free or entitled to duty rebates. Apart from the Customs import tariff there are other taxes which make consumer goods imports expensive and inaccessible to a majority of Sri Lankans. Over the years the government has liberalized most license controls. Recently, license controls on rice, motor vehicles, gold and gems were lifted. Wheat is still controlled. Only a few other items remain under license control, mostly for health and national security reasons. The Sri Lankan government actively encourages foreign investment. Non-nationals can purchase up to 100 percent of equity in Sri Lankan companies (in most sectors) free of any transfer tax. The Board of Investment (BOI) is the primary government authority responsible for foreign investment. To qualify for BOI incentives, a foreign investor must produce almost totally for export. Attractive incentives are available for other projects including infrastructure and hotels. In certain sectors (e.g. telecommunications, shipping, education, and tea, rubber and coconut plantations) foreign investors are normally permitted to invest only up to 40 percent of the issued capital. A few other sectors like finance, mining and energy, have restrictions on foreign equity that are determined by the regulatory authorities. High interest costs (currently running over 18 percent) are a fact of life faced by the local business community, but foreign investors and BOI-approved local firms can raise finances through dollar interest rates. Labor Force Sri Lanka's labor force is educated. The literacy rate is high at 88 percent and its standard of English is above many other Asian countries. Although the Sri Lankan labor force is currently weak in technical skills, it is trainable. There is a shortage of technical and managerial personnel. Expatriate personnel are permitted when there is a demonstrated shortage of qualified local labor. Sixty six percent of the labor force is male and thirty three percent female. There are no reliable unemployment statistics in Sri Lanka. The unemployment rate, according to the Department of Census and Statistics, in the 4th quarter of 1993 was running around 14 percent with an estimated 840,000 people out of work (excluding the north and east). Unemployment is highest in 15-24 age group. High unemployment, especially among educated youth, remains a major concern for policy makers. In 1993, wages of government employees were increased. Plantation workers and workers in garment factories also received wage increases. The government has decided on a national minimum wage of Rs. 2000 ($40) per month from January 1, 1995. Major Local and Third Country Competitors in Specific sectors Sri Lanka produces a limited range of light manufacturing and agricultural products for the local market and a range of products for the export market including garments, gems and jewelry and agro/industrial products. The country's main imports consist of textiles and machinery and equipment. Imports of inputs for the garment industry are mainly sourced from Hong Kong, South Korea, Taiwan, Japan and India. Machinery and equipment mostly come from Europe and Japan. In certain sectors such as consumer products China, Taiwan and India dominate the market. Japanese, European and Australian competition is strong in major projects. In certain high tech areas, such as computers, the U.S. is the leader. Infrastructure Situation Re: Goods/Service Distribution Sri Lanka is strategically located along the Europe-Far East shipping routes. Sri Lanka is served by one international air port located near Colombo and three commercial ports, the largest and most commonly used being the Port of Colombo. Although ranked among the top 25 such facilities in the world by Lloyds, the Colombo Port last year faced a serious set back due to a shortage of equipment and space. The port has recently acquired new equipment and expansion of port terminals are underway. Road transportation accounts for eighty percent of inland transportation. However, Sri Lanka's road network of over 25,000 kilometers is old and, due to poor maintenance, remains the most serious infrastructure constraint. Developing road and rail networks is becoming increasingly crucial as industry and commerce decentralize from the capital city, Colombo. Major Infrastructure Projects Underway Sri Lanka has ambitious plans for developing its infrastructure over the next ten years through private investment. The following projects have been identified: Power and Energy: Addition of 800MW of generating capacity in the next eight years at an estimated cost of $1.4 billion. Telecommunications: 60,000 telephone lines to be added to the national network. Solid Waste Management: A project for composting garbage in the Capital city Colombo.