Sri Lanka to benefit from Asia’s continued momentum
Friday, 2 May 2014 00:27
Asia is well positioned to capitalise on the largely favourable global trends and enjoy steady growth in 2014-15. Policy actions to address vulnerabilities have started to bear fruit. With vigilance and further reform, Asia should remain resilient to global risks and continue to be a dynamic force driving the strengthening global recovery. Sri Lanka weathered market turbulence in 2013 and 2014 comparatively well and there is good reason to believe this resilience can continue.
How do we arrive at these conclusions in our latest Regional Economic Outlook? First, global activity has been firming up, and this will help Asia’s exports — particularly Sri Lanka, which shipped 60% of its goods to advanced economies last year.
Growth has gathered steam in the United States and the euro area, thanks to a reduction in fiscal tightening, and still accommodative monetary conditions. And while some large emerging market economies have slowed, overall growth in emerging markets has picked up. Stock markets across most of the globe have reflected those trends and many have reached all time highs.
Second, the largest economies in the region are also doing well, despite some challenges. China’s reform agenda has boosted sentiment, and growth should moderate only slightly to 7.5% in 2014. Japan’s Abenomics has lifted confidence — inflation and growth there should remain above trend at 1.4% in 2014. In India, growth in 2014-15 should rise to 5.4% as investment projects are implemented, exports benefit from improved competitiveness and global growth, and confidence is lifted by recent policy actions.
Favourable trends in the largest players are benefitting the rest of the region, together with healthy labour markets and robust credit growth in many economies. The overall outlook for Asia is one of steady, robust growth of about 5.5% in 2014-15 — perhaps not as high as a few years ago, but still enviable by international standards.
Third, external risks have receded in Emerging Asia, including when compared to some emerging economies in other regions. Asia’s emerging markets moved swiftly to address their vulnerabilities following last year’s market turbulence, and now have stronger macroeconomic fundamentals.
So far so good for Asia, but this outlook assumes that risks remain dormant. An unexpectedly rapid tightening of global liquidity would again affect the region. Domestic vulnerabilities could magnify the impact: as interest rates rise, vulnerabilities stemming from pockets of high corporate leverage and household indebtedness would come to the fore. In addition, economies with weaker fundamentals would be hard hit, similar to what happened a year ago when markets abruptly revised their expectations of future US monetary policy. Asia also faces risks from within – including a sharper-than-envisaged slowdown and financial sector vulnerabilities in China, a waning impact of Abenomics, and political tensions and uncertainty.
Continued macro-economic and structural policy momentum can help keep risks at bay, maintain investor confidence and sustain the region’s growth leadership. Decisive progress on structural reforms is critical. The agenda varies across the region, involving vigorous implementation of China’s reform blueprint to put growth on a more sustainable; further product and labour market reforms to prevent the return of deflation and low growth in Japan; and lifting regulatory impediments, boosting infrastructure and continuing to promote trade and financial integration in many emerging, frontier and developing economies, as well as in Pacific island countries and small states.
Sri Lanka clearly stands to benefit from a favourable external environment. Certainly the past year has been much applauded for high growth and low inflation. Continued fiscal and debt consolidation and a steady approach to policies that maintains an investor-friendly environment and strong outward orientation will be essential to supporting the kind of growth and resilience seen thus far. This may seem obvious, but there are reasons for Sri Lanka to work hard on differentiating itself and providing a sense of assurance. These include:
A chronic current account deficit. While the external balance improved in 2013, a substantial part of this shift came through lower imports. This seems unlikely to continue in the context of strong GDP growth.
Falling government revenues. Steady reduction of the budget deficit is welcome, but recent gains have been made on the back of expenditure cuts, while government revenues as a share of GDP have actually fallen. This is worrisome given the need for fiscal space to meet critical investment needs and service debt.
High debt and debt service. Public debt as a share of GDP declined only marginally in 2013 and still hovers close to 78%. This is one of the higher ratios in the region, and Sri Lanka is even more of an outlier if debt is set against government revenue. Interest payments on public debt are now higher than capital expenditures.
In sum, Asia is set to do well and Sri Lanka could benefit. But with tightening liquidity on the horizon, and the potential for more market bumps down the road, continued progress on reforms to boost productivity and enhance growth is needed, as will efforts to chip away at the vulnerabilities that could at some point play against Sri Lanka’s stability.