Growth challenges

Sri Lanka’s first quarter import and export numbers released by the Central Bank this week reinforce what people have already known for a while, which is that the economy has been sluggish well before the Easter Sunday attacks. As much as half of imports are intermediate goods used for exports and a slump in imports also shows that local consumption is shrinking, partly due to Government policies protect foreign reserves. The situation has many experts predicting a policy rate cut by the Central Bank later this week to drive down interest rates. But will this be enough to push growth? Imports dropped a steep 19.3% in the first quarter of 2019, even though export earnings increased by 5.6% year-on-year as the trade deficit contracted to $ 1,661 million from $ 2,982 million recorded in the first quarter of 2018. Bringing a spark of hope the Central Bank also said March exports were the highest ever and was optimistic that imports would pick up in the second quarter despite a shaky start with the Easter Sunday attacks. Slow private sector credit growth, moderate inflation, steady rupee and other sound macroeconomic fundamentals have set the stage for the Central Bank to reduce policy rates, which will be announced on Friday.   

With elections around the corner, the Government is understandably keen to shed its image of imposing high interest rates and present a more pro-business image. While reduced interest rates would be positive for the economy, the link between capital that can be obtained at somewhat lower levels and growth is a tenuous one, with most companies and investors taking a range of points into consideration before making a commitment to expand. Central Bank Governor Dr. Indrajit Coomaraswamy has noted that Sri Lanka’s private credit fell by Rs. 4.3 billion in January and grew by Rs. 7.6 billion in February. The Governor has said if the 13.5% annual private credit growth target for 2019 is to be achieved, credit growth has to average Rs.75 billion per month for the rest of the year.

Experience shows that no country in the world has been able to create opportunities for its population entirely within its own geographic boundaries. To succeed in this open environment, Sri Lanka will need to improve its skills base, better understand supply and demand chains as well as produce higher quality goods and services. Sri Lanka attracts less foreign investment than other comparable economies - and only a small proportion of these investments generate diversified exports or jobs. A significant part of this effort will also include improving trade competitiveness by reducing the time and cost required to fulfil regulatory processes to import and export. These policies have been tied to improving Sri Lanka’s ranking in the Ease of Doing Business rankings. Access to capital, while important, does not necessarily improve access to markets, which is a significant challenge for many businesses looking to expand.  For economic growth that will be genuinely felt by the people, the Government also has to target policies that will assist the underproductive agriculture sector, which employs over 27% of the population and tends to be a strong vote bank as well. Pushing down interest rates will also have limited impact because they usually spillover into imports, which the economy with its low reserves cannot support. This means the Central Bank will likely continue implementing macro prudential measures to guard against increased vehicle imports and construction. Perhaps the strongest need is national security and political stability. The latter will be unlikely until the presidential elections are resolved and could be the biggest challenge to growth.