Future prospects of Sri Lankan economy – 2013 and beyond

In this general backdrop, we expect 2013E real GDP to grow by a minimum of 6.6% YoY and the nominal GDP to grow 14.03% YoY to Rs. 8,689.1 billion. We expect the annual average rate of inflation to ease to 5.5% in 2013 from 7.6% in 2012 and the Average Weighted Lending Rate (AWLR) during the year to stabilise at around 15.5% reversing the increasing trend of interest rates in 2012. The removal of the credit growth ceiling imposed on the banking sector by the monetary authority will take effect from January 2013 onwards. On account of this measure we expect the AWLR to marginally dip during the year and also the banking sector to move into more long term financing.

Hence, supply and cost of capital for investments will tend to remain at a relatively favourable range in 2013 compared to 2012. We expect the external sector is expected to retain its stability in 2013 in account of the market and nonmarket measures adopted by fiscal and monetary authorities during 2012 to offset the deficit in the current account of the balance of payments. Further, tourism sector is likely to remain decoupled from the waning demand prospects in the world markets unlike the exports sector and hence may continue to outperform the output growth of the rest of the economy. This is to say

that the locally based backward linkages of tourism such as poultry are highly likely to benefit from the current boom in the leisure sector.

We expect the government’s financial position to consolidate on the back of upward revision of consumer taxes and fuel prices during the second half of 2012, despite the aggregate demand in the economy is likely to moderate during the course of the year. Hence, total tax revenue growth is likely to converge with the rate of expansion of the nominal GDP contributing positively towards revenue growth and easing the deficit position during the year.

However, given that, unavoidable costs of the government (e.g. salaries and wages and interest and capital payments) as a ratio of revenue has been rising, thus the resources available to public services such as healthcare, education, waste disposal and transfer payments would remain limited. On the other hand, a possible inadequate growth of state resources is likely to further reduce the supply quality and supply quantity of services traditionally provided by the government in the long run. This in turn may open up fields such as education, health care, waste management and security services for private investments and the composition of the supply of these particular services is likely to shift from government to the private sector and hence, may turn favourable towards the latter. Especially, healthcare, which is a material intensive process relative to other public services such as education and waste disposal, will be susceptible to this trend more than other spheres. Hence, private investments in healthcare could be expected to increase in the medium to long run which is likely to provide higher relative returns comparable to that of tourism. Hence, the sector remains attractive for long term direct capital allocations as well as for equity investments. Furthermore, given the relative non-tradability of service oriented activities, (that is to say that services sector compared to industry and agriculture is less prone to enter trade across national boundaries) these fields remain inherently protected from external competitive forces providing further comparative advantage for private investments. Hence, we expect the private sector to increase its presence in these fields, and in the long run account for a larger share of output in these sectors.