magerata

Sri Lankan Economy Set To Expand In 2010, Sri Lanka Central Bank Report.

In development, magerata on April 5, 2010 at 7:23 pm

The Sri Lankan economy expanded 3.5%  in 2009 despite a number of external and domestic economic downturns and other surprises, according to the the central bank Sri Lanka.

The phase is going to rise this year and it is estimated to grow 6.5% and The central bank forecasts the overall budget deficit to narrow to 7.5% of GDP this year from 9.8% in 2009. The combined outcome of a shortfall in revenue, overrun in recurrent expenditure and increased expenditure on infrastructure projects accounted for the deficit in 2009.

“The end to the prolonged internal conflict and the restoration of peace provide a greater optimism for economic prosperity and a strong basis for long-term sustainable development, supported by appropriate policies,” the report said.

President Mahinda Rajapaksa, who was reelected for a six- year term in January after defeating the Tamil Tiger rebels in May, has pledged to spend $1 billion on ports, roads and power plants in 2010. Usually infrastructure developments will spillover to promote  growth even further.

Central Bank Report could be found here. But be warned it is a word document (?). Perhaps someone should tell CBSL webmaster that there are solutions like, PDF and most press releases nowadays are even in plain HTML. Unless Central Bank  Governor Nivard Cabraal does not want everyone to easily access the mandated report.

Following is the press release in it’s entirety;

Communications Department

30, Janadhipathi Mawatha, Colombo 01, Sri Lanka.

Tel : 2477424, 2477423, 2477311

Fax:  2346257, 2477739

E-mail: dcommunications@cbsl.lk, communications@cbsl.lk

Web: http://www.cbsl.gov.lk

THE SUMMARY OF THE ANNUAL REPORT OF THE CENTRAL BANK OF SRI LANKA FOR THE YEAR 2009
Section 35 of the Monetary Law Act requires the Monetary Board of the Central Bank of Sri Lanka (CBSL) to submit a report giving details of the state of the economy, the condition of the Central Bank and the policies and measures adopted by the Monetary Board during the year to the Minister in charge of the subject of Finance within four months of the commencement of the following year. The 60th annual report of the Monetary Board was submitted to H.E. the President of Sri Lanka and the Minister of Finance and Planning today, the 5th of April 2010. Following are some of the highlights of the report.
The economy of Sri Lanka demonstrated its resilience by growing at 3.5 per cent in 2009 amidst challenging domestic and external conditions. This remarkable performance was largely due to the steady recovery in the economy since the second quarter of the year, resulting in a notable growth of 6.2 per cent in the final quarter. On the external front, Sri Lanka continued to be impacted by the spill-over effects of the global financial and economic crises, while domestically, the conflict, which had ravaged the country for almost three decades reached a critical juncture during the early part of the year. The sudden withdrawal of short term capital by foreign investors resulting from adverse global conditions placed an enormous strain on the country’s foreign reserves and the management of liquidity. The slump in global demand and the consequent contraction in external trade as well as the slowdown in domestic economic activity had a negative impact on government revenue. In addition, higher government expenditure on defence, interest payments, salaries and wages as well as the continued expenditure on urgent resettlement, rehabilitation and reconstruction (RRR) activities exerted a heavy burden on government finances.
Despite these unprecedented challenges, the country made an extraordinary recovery in the second half of the year. The end to the prolonged conflict and the coordinated and timely policy actions of CBSL and the government, including the securing of the Stand-by Arrangement (SBA) from the International Monetary Fund (IMF) and measures taken to preserve financial system stability, were instrumental in turning around the domestic economy. Enhanced investor confidence in the economy saw a sharp reversal in foreign financial flows helping the country to record an unprecedented surplus in the balance of payments (BOP) of US dollars 2.7 billion by end 2009 and raising foreign exchange reserves from a low level of US dollars 1.1 billion in March 2009 to a historic high of US dollars 5.1 billion by end 2009.
A notable achievement in 2009 was the sharp deceleration in inflation, a result of the stringent monetary policy measures adopted by CBSL over the last two years and the significant decline in global commodity prices. Inflation, as measured by the year-on-year change in the Colombo Consumers’ Price Index (CCPI), which reached 28.2 per cent in June 2008, declined sharply to 4.8 per cent by end 2009, recording an average rate of 3.4 per cent in 2009, the lowest since 1985. This enabled CBSL to relax its monetary policy stance to support the domestic economy, which was affected by the global economic downturn. The Penal rate of interest applicable on reverse repurchase (reverse repo) transactions with CBSL when participating institutions exceeded their monthly quota, which served as an effective ceiling for interbank interest rates was reduced gradually from 19 per cent in January 2009 and was harmonised with the Reverse Repo rate in May 2009. Further, Repo and Reverse Repo rates were brought down in several steps to 7.5 per cent and 9.75 per cent, respectively. In response to the significant reduction in policy interest rates, there was a substantial downward adjustment of market interest rates across the term structure, albeit with a time lag. However, the demand for credit from the private sector remained subdued largely due to the sluggish recovery in the domestic and the global economies as well as the cautious approach to lending by banks. However, monetary growth, which remained subdued during the first half of the year, began to increase during the second half with the unprecedented expansion in net foreign assets (NFA).
The policy action of CBSL, supported by the government, successfully mitigated the contagion of the global financial crisis and the failure of a few entities connected to certain domestic financial institutions. The strong regulatory and supervisory framework and enhanced risk management systems that have been put in place over time enabled the financial system to withstand the shocks from the external and domestic fronts and maintain confidence in the financial system. However, the spill-over effects of the global economic downturn on the domestic economy posed a challenge for banks and other financial institutions. In this challenging environment, financial institutions remained profitable and reasonably well capitalised, although credit risk increased due to tight market conditions.
The impact of the challenging domestic and global environment resulted in an overall set-back in fiscal operations in 2009. Despite several revenue measures introduced during the year, there was a significant shortfall in revenue due to the slowdown in economic activities and the contraction in imports. In addition, government expenditure increased due to higher security related spending during the decisive phase of the conflict and continued urgent RRR activities in the second half of the year, as well as increased salaries and wages, interest payments and expenditure on continuing public investment projects. Accordingly, the budget deficit widened to 9.8 per cent of GDP in 2009 compared to the revised target of 7.0 per cent leading to an increase in the borrowing requirement. In financing the deficit, greater reliance was placed on domestic sources during the early part of 2009. However, the availability of foreign financing during the latter part of the year enabled the settlement of some high cost domestic debt. The higher financing requirement together with lower growth in nominal GDP led to an increase in the debt to GDP ratio, reversing the declining trend observed in the recent past.
Real Sector Developments
The economy grew by 3.5 per cent, in real terms, in 2009, a commendable achievement in spite of a number of external and domestic shocks. The economy recovered strongly to record a notable 6.2 per cent growth in the fourth quarter from 1.6 per cent in the first quarter. The impact of adverse global developments that affected almost all sectors of the economy at varying levels, and unfavourable domestic weather conditions that lowered agricultural output were the main causes for the lower growth rates in the first quarter. However, since the second quarter, growth has rebounded driven by the end to the conflict and the gradual recovery of the global economy.
In 2009, all major sectors of the economy contributed positively to economic growth. The Agriculture sector recorded a low growth of 3.2 per cent compared to a high growth of 7.5 per cent in 2008, mainly owing to the contraction in the output of tea and paddy. However, within the Agriculture sector, the fisheries sub-sector performed well recording a 6.9 per cent growth driven by increased coastal fishing with the relaxation of security restrictions. While tea production was adversely affected by the drought in the major tea planting districts in the early part of the year, paddy production in the Yala season was severely affected as a result of the delay in the monsoon. Coconut production in 2009 declined largely owing to the lagged effect of the unfavourable weather conditions that prevailed during the previous year. Sugar production also declined during the year due to the decline in sugar cane supply on account of adverse weather conditions. Nevertheless, the healthy performances of several sub-sectors, such as rubber, other field crops mainly maize and big onions, fisheries and livestock, helped maintain a moderate growth in the Agriculture sector in 2009.
The Industry sector slowed down registering a growth rate of 4.2 per cent compared to a growth of 5.9 per cent in 2008. All sub-sectors of the Industry sector, except for electricity, gas and water, recorded low growth rates compared to the previous year, largely as a result of the fall in demand in both international and domestic markets. The output of textile, wearing apparel and leather products, rubber based products and other export market based products recorded a low growth in 2009. However, major players in the textile, wearing apparel and leather products category continued to maintain their competitiveness by supplying high quality and high valued products.  Small and medium scale manufacturers were affected by the low demand in both export and domestic markets and the increase in the cost of production. Lower growth in disposable income and subdued performance in the construction sub-sector contributed towards the low demand for domestic market oriented industries. However, the food, beverages and tobacco products category was able to maintain its growth momentum in 2009 as a result of access to new markets in the Northern and the Eastern provinces and the revival of tourism, including domestic tourism, during the second half of the year.
The Services sector grew by 3.3 per cent in 2009 contributing 55 per cent to the overall economic growth. The wholesale and retail trade sub-sector, which is the largest contributor to the Services sector, registered a sluggish performance, mainly reflecting the contraction in import and export trade. The transport and communication sub-sector also slowed down considerably due to the low growth in telecommunication services and cargo handling. The hotels and restaurants sub-sector recovered strongly compared to the set-back it faced in 2008, due to the end of conflict and the expansion in both local and foreign tourist activities. Meanwhile, the banking, insurance and real estate sub-sector grew moderately due to the slowdown in domestic economic activity.
In 2009, total investments of the country declined, while the savings and investment gap narrowed. Private investment declined significantly to 17.9 per cent of GDP from 21.1 per cent in the previous year, while public investment increased marginally to 6.6 per cent. As a result, total investment as a percentage of GDP declined to 24.5 in 2009 from 27.6 in 2008. Meanwhile, national savings increased to 23.9 per cent of GDP from 17.8 per cent in the previous year. The decline in investments coupled with the significant increase in national savings narrowed the savings-investment gap to 0.7 per cent of GDP in 2009 from 9.8 per cent in 2008, reflecting the significant contraction in the current account deficit of the BOP.
The slowdown in domestic economic activity resulted in a marginal increase in the unemployment rate (excluding the Northern Province), to 5.8 per cent in 2009 from 5.4 per cent in 2008.
External Sector Developments
The external sector recovered strongly during 2009 amidst a challenging global economic environment. The external sector position deteriorated from the latter part of 2008 until the end of the first quarter of 2009. The sharp outflow of foreign investment, the non-rollover of short-term debt, drying up of new commercial financing and higher petroleum bills were the main reasons for this downturn. Amidst the challenging domestic and external environment, gross official reserves declined to a low level by end March 2009. However, with the end to the conflict and improved investor confidence, the external sector rebounded strongly, recording the highest ever level of reserves by end of the year.
External trade, which contracted in 2009 due to the impact of the global economic crisis, improved towards the latter part of the year. Earnings from exports declined by 12.7 per cent, led by lower demand for industrial exports, while expenditure on imports declined by 27.6 per cent, mainly due to the substantially lower expenditure on petroleum and fertilizer imports. Accordingly, the trade deficit contracted by 47.8 per cent to US dollars 3,122 million in 2009 compared to the 63.6 per cent expansion in 2008 to US dollars 5,981 million, reflecting a significantly larger reduction in import expenditure in 2009 relative to the decline in export earnings.
The current account of the BOP improved remarkably due to the lower trade deficit and increase in migrant workers’ remittances. In spite of the sluggish growth in the first quarter of the year, workers’ remittances grew by 14.1 per cent to US dollars 3,330 million in 2009. The current account, which recorded a surplus of US dollars 339 million for the first nine months of the year, turned around to record a deficit of US dollars 214 million due to the increase in the trade deficit during the last quarter of 2009. The current account deficit was US dollars 3,886 million in 2008. As a percentage of GDP, the current account deficit narrowed substantially from 9.5 per cent in 2008 to a marginal level of 0.5 per cent in 2009. The inflows to the capital and financial account increased substantially during the second half of the year.
As a result of these developments, the overall BOP, which was a deficit of US dollars 1,385 million in 2008, recorded an unprecedented surplus of US dollars 2,725 million in 2009. The BOP recorded a deficit of US dollars 688 million by end of the first quarter of 2009. However, it improved to record a surplus from the second quarter of the year in response to measures taken by CBSL, which was further reinforced by improved investor confidence with the ending of prolonged conflict and the approval of the IMF-SBA facility of Special Drawing Rights (SDR) 1.65 billion (US dollars 2.6 billion) as BOP support. The first two tranches of the SBA facility amounting to US dollars 652 million and the SDR allocations by IMF of US dollars 508 million were received during the second half of the year. Accordingly, the total external official reserves, excluding Asian Clearing Union (ACU) receipts, rose to its highest ever level of US dollars 5,097 million by end 2009 compared to US dollars 1,594 million at end 2008, which was sufficient to cover 6 months of imports compared to 1.4 months of imports in 2008.
Fiscal Sector Developments
The fiscal sector came under severe stress in 2009 as in many other countries, resulting in a significant deviation from the original fiscal targets. According to Budget 2009, the overall budget deficit was expected to reduce to 5.9 per cent of GDP after grants. However, with the subsequent developments in the domestic as well as the external fronts, the budgetary estimates were revised, targeting an overall deficit of 7.0 per cent of GDP. During the first half of 2009, there was a severe strain on fiscal operations mainly due to the lower growth in government revenue as a result of the slowdown in domestic economic activity and the contraction of imports reflecting the adverse impact of the global economic crisis. Meanwhile, the intensified security situation, urgent RRR activities in the Northern and the Eastern provinces and increased interest payments, while continuing expenditure on the public investment programme, raised government expenditure. During the second half of the year, the positive impact of the ending of the conflict in May 2009 and the rebound in domestic economic activity in line with the gradual recovery in the global economy eased fiscal operations to some extent, with the overall budget deficit recording 9.8 per cent of GDP in 2009.
The high deficit was a combined outcome of a shortfall in revenue, overrun in recurrent expenditure and increased expenditure on infrastructure projects. The government revenue was significantly below the targeted level. The total revenue as a percentage of GDP declined to 14.6 per cent in 2009 compared to 14.9 per cent in 2008 and 16.3 per cent in 2006. Meanwhile, total expenditure and net lending increased to 24.9 per cent of GDP, compared to that of 22.6 per cent in 2008 and 24.3 per cent in 2006. Recurrent expenditure increased significantly, as a percentage of GDP to 18.2 per cent from 16.9 per cent in 2008. Public investment increased to an encouraging level of 6.8 per cent of GDP in 2009 compared to 6.0 per cent in the previous year.
In financing the deficit, the government raised more funds from domestic sources during the early part of 2009 and from foreign sources during the latter part of the year. The increased borrowing requirement and the tight liquidity conditions in the international capital markets led the government to depend heavily on domestic borrowings during first half of the year. However, the significant increase in foreign investments in government securities and the receipt of proceeds from the international sovereign bond during the second half of the year enabled the government to retire a large amount of Treasury bills held by CBSL. As a result, total borrowing from the banking sector declined to Rs. 49 billion by end 2009 compared to Rs. 189.6 billion at end July 2009. Total net domestic financing in 2009 amounted to 5 per cent of GDP while net foreign financing was 4.8 per cent of GDP, which consisted of foreign loans (1.8 per cent of GDP) and foreign investments in government securities (3.0 per cent of GDP). Meanwhile, the outstanding government debt to GDP ratio increased slightly to 86.2 per cent in 2009 mainly reflecting the higher budget deficit and the lower growth in nominal GDP.
Monetary Sector Developments
CBSL relaxed its monetary policy stance in 2009 to support domestic economic activity. Accordingly, the Penal interest rate applicable on reverse repo transactions when participating institutions exceeded the maximum number of times they could access the reverse repo window, which was introduced in November 2007, was reduced gradually and harmonised with the Reverse Repo rate in May 2009. At the same time, restrictions on access to Central Bank’s repo and the reverse repo facilities were also removed, thus re-establishing the interest rate corridor. The Central Bank’s policy interest rates were also gradually reduced during the year: the Repo rate was reduced by 300 basis points to 7.50 per cent and the Reverse Repo rate was reduced by 225 basis points to 9.75 per cent. In addition, margin deposit requirements that were imposed to restrict the demand for credit for certain categories of vehicle and non-essential imports, were removed during the first half of the year, to ease credit conditions.
CBSL took timely and appropriate measures to manage rupee liquidity in the market. The continued capital outflows during the first quarter of the year necessitated CBSL to supply foreign currency to the market resulting in a drain in rupee liquidity from the market. CBSL lowered the Statutory Reserve Ratio (SRR) by a further 75 basis points to 7 per cent in February 2009, following the reduction in the SRR imposed on all rupee deposits of commercial banks by 225 basis points in the last quarter of 2008 releasing about Rs.9 billion to the market. In addition, CBSL purchased Treasury bills from the primary market, while also engaging in reverse repo transactions to enhance rupee liquidity. CBSL also removed the restriction on access to reverse repo standing facility by market participants in 2009.
However, since June 2009, there has been a turnaround in liquidity, posing a challenge to managing the surplus. Renewed investor confidence with the end to the conflict and the securing of the SBA facility from IMF substantially increased foreign investments in government securities from May 2009 onwards. The proceeds of these inflows were purchased by CBSL to stabilise the foreign exchange market and to build official reserves. The resulting increase in rupee liquidity in the market was absorbed through the Central Bank’s open market operations (OMO), thus leading to a significant reduction in the Central Bank’s holdings of government securities necessitating the use of alternative instruments to conduct OMO. Accordingly, Central Bank Securities were issued to absorb liquidity on overnight basis and term basis from October 2009. In addition, CBSL commenced foreign exchange swap transactions as an additional instrument for absorbing liquidity from November 2009.
The targets for monetary aggregates, which were initially set out in the Monetary Programme for 2009 and announced in the Central Bank’s ‘Road Map: Monetary and Financial Sector Policies for 2009 and beyond’ (Road Map) were subsequently revised downward. The reduction in the SRR, the rapid decline in inflation and the slowdown in the domestic economy were the main factors that warranted this downward revision. Accordingly, the target for the growth in reserve money was revised downward from 5 per cent to 2.8 per cent, while that of broad money was lowered from 14 per cent to 13 per cent. Although the growth in reserve money contracted during the first three quarters of 2009 largely due to the lowering of SRR in the last quarter of 2008 and the first quarter of 2009, it began to increase in the last quarter of 2009, due to the increase in credit to the government from CBSL and the dissipation of the impact of the changes in SRR in the last quarter of 2008, on reserve money. Accordingly, the annual average growth in reserve money contracted by 0.7 per cent, which was within the target set in the revised Monetary Programme for 2009.  The growth in broad money, which moderated during the first half of the year, gathered pace thereafter, with annual average broad money growing by 13.6 per cent, which was marginally above the target set in the revised Monetary Programme for 2009.
Interest rates across the term structure shifted downwards in line with the changes in the policy rates and the improvements in market liquidity. The average weighted call money rate (AWCMR) was brought within the policy interest rate corridor, improving the effectiveness of the Central Bank’s monetary policy operations. Other market interest rates also declined in line with these changes, although lending rates of commercial banks declined at a slower pace.
Financial System Stability
During 2009, the financial sector remained resilient and financial system stability was maintained despite challenging market conditions. Financial sector institutions were confronted with the stresses caused by the spill-over effects of the global financial crisis and the consequent decline in demand in the domestic economy which had an adverse impact on their business operations. As the global financial turmoil deepened and the global economy contracted, there was an outflow of foreign investments in government securities creating a liquidity shortage in money markets, although this situation turned around with the money market becoming liquid and the equity market rebounding after the end of the conflict in May 2009. The loss of investor confidence and liquidity constraints faced by several entities connected to banks and finance companies in the Ceylinco Group had an adverse impact on the finance and leasing sectors.
However, swift and decisive actions taken by CBSL and the government contributed towards restoring public confidence and continued stability in the financial system. CBSL successfully resolved the liquidity problems encountered by Seylan Bank, a systemically important licensed commercial bank (LCBs), which was a part of the Ceylinco Group. Seylan Bank was recapitalised by issuing new shares and is currently carrying on normal business operations. With a view to resolving the liquidity constraints faced by distressed registered finance companies (RFCs) and specialised leasing companies (SLCs) in the Ceylinco Group, CBSL appointed managing agents and obtained the services of a panel of experts to advise and guide the recovery process. In addition, a special stimulus package and a guarantee scheme were put forward by CBSL with the support of the government to assist RFCs and SLCs that were experiencing liquidity problems. These measures were successful in facilitating the commencement of business operations and bringing stability to the sector.
Outlook
The end to the prolonged internal conflict and the restoration of peace provide a greater optimism for economic prosperity and a strong basis for long-term sustainable development, supported by appropriate policies. The opportunities created by the restoration of peace, will be complemented by the ongoing global economic recovery. The low inflation and interest rate regime that prevails also provides a conducive environment to fuel economic activities. To harness these opportunities, the existing bottlenecks that hinder a faster growth need to be addressed urgently. Infrastructure projects, already commenced and planned, need to be accelerated to expand the productive capacity of the economy and to improve the efficiency and productivity of economic activities. At the same time, special attention needs to be paid to implement much needed structural and institutional improvements, including the enhancement of the profitability and productivity of public enterprises that are a significant drain on public finances. The fiscal consolidation process also needs to be strengthened. The contribution of the private sector to overall economic development needs to be increased. The regulatory framework has to be further strengthened. Establishment of a strong development planning and monitoring process would be helpful to prioritise projects, avoid delays and ensure the optimal allocation of resources. In the short to medium-term, moving to a high growth trajectory, while maintaining price stability remains a key policy challenge.

THE SUMMARY OF THE ANNUAL REPORT OF THE CENTRAL BANK OF SRI LANKA FOR THE YEAR 2009
Section 35 of the Monetary Law Act requires the Monetary Board of the Central Bank of Sri Lanka (CBSL) to submit a report giving details of the state of the economy, the condition of the Central Bank and the policies and measures adopted by the Monetary Board during the year to the Minister in charge of the subject of Finance within four months of the commencement of the following year. The 60th annual report of the Monetary Board was submitted to H.E. the President of Sri Lanka and the Minister of Finance and Planning today, the 5th of April 2010. Following are some of the highlights of the report.   The economy of Sri Lanka demonstrated its resilience by growing at 3.5 per cent in 2009 amidst challenging domestic and external conditions. This remarkable performance was largely due to the steady recovery in the economy since the second quarter of the year, resulting in a notable growth of 6.2 per cent in the final quarter. On the external front, Sri Lanka continued to be impacted by the spill-over effects of the global financial and economic crises, while domestically, the conflict, which had ravaged the country for almost three decades reached a critical juncture during the early part of the year. The sudden withdrawal of short term capital by foreign investors resulting from adverse global conditions placed an enormous strain on the country’s foreign reserves and the management of liquidity. The slump in global demand and the consequent contraction in external trade as well as the slowdown in domestic economic activity had a negative impact on government revenue. In addition, higher government expenditure on defence, interest payments, salaries and wages as well as the continued expenditure on urgent resettlement, rehabilitation and reconstruction (RRR) activities exerted a heavy burden on government finances. Despite these unprecedented challenges, the country made an extraordinary recovery in the second half of the year. The end to the prolonged conflict and the coordinated and timely policy actions of CBSL and the government, including the securing of the Stand-by Arrangement (SBA) from the International Monetary Fund (IMF) and measures taken to preserve financial system stability, were instrumental in turning around the domestic economy. Enhanced investor confidence in the economy saw a sharp reversal in foreign financial flows helping the country to record an unprecedented surplus in the balance of payments (BOP) of US dollars 2.7 billion by end 2009 and raising foreign exchange reserves from a low level of US dollars 1.1 billion in March 2009 to a historic high of US dollars 5.1 billion by end 2009.A notable achievement in 2009 was the sharp deceleration in inflation, a result of the stringent monetary policy measures adopted by CBSL over the last two years and the significant decline in global commodity prices. Inflation, as measured by the year-on-year change in the Colombo Consumers’ Price Index (CCPI), which reached 28.2 per cent in June 2008, declined sharply to 4.8 per cent by end 2009, recording an average rate of 3.4 per cent in 2009, the lowest since 1985. This enabled CBSL to relax its monetary policy stance to support the domestic economy, which was affected by the global economic downturn. The Penal rate of interest applicable on reverse repurchase (reverse repo) transactions with CBSL when participating institutions exceeded their monthly quota, which served as an effective ceiling for interbank interest rates was reduced gradually from 19 per cent in January 2009 and was harmonised with the Reverse Repo rate in May 2009. Further, Repo and Reverse Repo rates were brought down in several steps to 7.5 per cent and 9.75 per cent, respectively. In response to the significant reduction in policy interest rates, there was a substantial downward adjustment of market interest rates across the term structure, albeit with a time lag. However, the demand for credit from the private sector remained subdued largely due to the sluggish recovery in the domestic and the global economies as well as the cautious approach to lending by banks. However, monetary growth, which remained subdued during the first half of the year, began to increase during the second half with the unprecedented expansion in net foreign assets (NFA).The policy action of CBSL, supported by the government, successfully mitigated the contagion of the global financial crisis and the failure of a few entities connected to certain domestic financial institutions. The strong regulatory and supervisory framework and enhanced risk management systems that have been put in place over time enabled the financial system to withstand the shocks from the external and domestic fronts and maintain confidence in the financial system. However, the spill-over effects of the global economic downturn on the domestic economy posed a challenge for banks and other financial institutions. In this challenging environment, financial institutions remained profitable and reasonably well capitalised, although credit risk increased due to tight market conditions.The impact of the challenging domestic and global environment resulted in an overall set-back in fiscal operations in 2009. Despite several revenue measures introduced during the year, there was a significant shortfall in revenue due to the slowdown in economic activities and the contraction in imports. In addition, government expenditure increased due to higher security related spending during the decisive phase of the conflict and continued urgent RRR activities in the second half of the year, as well as increased salaries and wages, interest payments and expenditure on continuing public investment projects. Accordingly, the budget deficit widened to 9.8 per cent of GDP in 2009 compared to the revised target of 7.0 per cent leading to an increase in the borrowing requirement. In financing the deficit, greater reliance was placed on domestic sources during the early part of 2009. However, the availability of foreign financing during the latter part of the year enabled the settlement of some high cost domestic debt. The higher financing requirement together with lower growth in nominal GDP led to an increase in the debt to GDP ratio, reversing the declining trend observed in the recent past.Real Sector DevelopmentsThe economy grew by 3.5 per cent, in real terms, in 2009, a commendable achievement in spite of a number of external and domestic shocks. The economy recovered strongly to record a notable 6.2 per cent growth in the fourth quarter from 1.6 per cent in the first quarter. The impact of adverse global developments that affected almost all sectors of the economy at varying levels, and unfavourable domestic weather conditions that lowered agricultural output were the main causes for the lower growth rates in the first quarter. However, since the second quarter, growth has rebounded driven by the end to the conflict and the gradual recovery of the global economy.In 2009, all major sectors of the economy contributed positively to economic growth. The Agriculture sector recorded a low growth of 3.2 per cent compared to a high growth of 7.5 per cent in 2008, mainly owing to the contraction in the output of tea and paddy. However, within the Agriculture sector, the fisheries sub-sector performed well recording a 6.9 per cent growth driven by increased coastal fishing with the relaxation of security restrictions. While tea production was adversely affected by the drought in the major tea planting districts in the early part of the year, paddy production in the Yala season was severely affected as a result of the delay in the monsoon. Coconut production in 2009 declined largely owing to the lagged effect of the unfavourable weather conditions that prevailed during the previous year. Sugar production also declined during the year due to the decline in sugar cane supply on account of adverse weather conditions. Nevertheless, the healthy performances of several sub-sectors, such as rubber, other field crops mainly maize and big onions, fisheries and livestock, helped maintain a moderate growth in the Agriculture sector in 2009.The Industry sector slowed down registering a growth rate of 4.2 per cent compared to a growth of 5.9 per cent in 2008. All sub-sectors of the Industry sector, except for electricity, gas and water, recorded low growth rates compared to the previous year, largely as a result of the fall in demand in both international and domestic markets. The output of textile, wearing apparel and leather products, rubber based products and other export market based products recorded a low growth in 2009. However, major players in the textile, wearing apparel and leather products category continued to maintain their competitiveness by supplying high quality and high valued products.  Small and medium scale manufacturers were affected by the low demand in both export and domestic markets and the increase in the cost of production. Lower growth in disposable income and subdued performance in the construction sub-sector contributed towards the low demand for domestic market oriented industries. However, the food, beverages and tobacco products category was able to maintain its growth momentum in 2009 as a result of access to new markets in the Northern and the Eastern provinces and the revival of tourism, including domestic tourism, during the second half of the year.The Services sector grew by 3.3 per cent in 2009 contributing 55 per cent to the overall economic growth. The wholesale and retail trade sub-sector, which is the largest contributor to the Services sector, registered a sluggish performance, mainly reflecting the contraction in import and export trade. The transport and communication sub-sector also slowed down considerably due to the low growth in telecommunication services and cargo handling. The hotels and restaurants sub-sector recovered strongly compared to the set-back it faced in 2008, due to the end of conflict and the expansion in both local and foreign tourist activities. Meanwhile, the banking, insurance and real estate sub-sector grew moderately due to the slowdown in domestic economic activity.In 2009, total investments of the country declined, while the savings and investment gap narrowed. Private investment declined significantly to 17.9 per cent of GDP from 21.1 per cent in the previous year, while public investment increased marginally to 6.6 per cent. As a result, total investment as a percentage of GDP declined to 24.5 in 2009 from 27.6 in 2008. Meanwhile, national savings increased to 23.9 per cent of GDP from 17.8 per cent in the previous year. The decline in investments coupled with the significant increase in national savings narrowed the savings-investment gap to 0.7 per cent of GDP in 2009 from 9.8 per cent in 2008, reflecting the significant contraction in the current account deficit of the BOP.The slowdown in domestic economic activity resulted in a marginal increase in the unemployment rate (excluding the Northern Province), to 5.8 per cent in 2009 from 5.4 per cent in 2008.
External Sector DevelopmentsThe external sector recovered strongly during 2009 amidst a challenging global economic environment. The external sector position deteriorated from the latter part of 2008 until the end of the first quarter of 2009. The sharp outflow of foreign investment, the non-rollover of short-term debt, drying up of new commercial financing and higher petroleum bills were the main reasons for this downturn. Amidst the challenging domestic and external environment, gross official reserves declined to a low level by end March 2009. However, with the end to the conflict and improved investor confidence, the external sector rebounded strongly, recording the highest ever level of reserves by end of the year. External trade, which contracted in 2009 due to the impact of the global economic crisis, improved towards the latter part of the year. Earnings from exports declined by 12.7 per cent, led by lower demand for industrial exports, while expenditure on imports declined by 27.6 per cent, mainly due to the substantially lower expenditure on petroleum and fertilizer imports. Accordingly, the trade deficit contracted by 47.8 per cent to US dollars 3,122 million in 2009 compared to the 63.6 per cent expansion in 2008 to US dollars 5,981 million, reflecting a significantly larger reduction in import expenditure in 2009 relative to the decline in export earnings. The current account of the BOP improved remarkably due to the lower trade deficit and increase in migrant workers’ remittances. In spite of the sluggish growth in the first quarter of the year, workers’ remittances grew by 14.1 per cent to US dollars 3,330 million in 2009. The current account, which recorded a surplus of US dollars 339 million for the first nine months of the year, turned around to record a deficit of US dollars 214 million due to the increase in the trade deficit during the last quarter of 2009. The current account deficit was US dollars 3,886 million in 2008. As a percentage of GDP, the current account deficit narrowed substantially from 9.5 per cent in 2008 to a marginal level of 0.5 per cent in 2009. The inflows to the capital and financial account increased substantially during the second half of the year.As a result of these developments, the overall BOP, which was a deficit of US dollars 1,385 million in 2008, recorded an unprecedented surplus of US dollars 2,725 million in 2009. The BOP recorded a deficit of US dollars 688 million by end of the first quarter of 2009. However, it improved to record a surplus from the second quarter of the year in response to measures taken by CBSL, which was further reinforced by improved investor confidence with the ending of prolonged conflict and the approval of the IMF-SBA facility of Special Drawing Rights (SDR) 1.65 billion (US dollars 2.6 billion) as BOP support. The first two tranches of the SBA facility amounting to US dollars 652 million and the SDR allocations by IMF of US dollars 508 million were received during the second half of the year. Accordingly, the total external official reserves, excluding Asian Clearing Union (ACU) receipts, rose to its highest ever level of US dollars 5,097 million by end 2009 compared to US dollars 1,594 million at end 2008, which was sufficient to cover 6 months of imports compared to 1.4 months of imports in 2008.
Fiscal Sector DevelopmentsThe fiscal sector came under severe stress in 2009 as in many other countries, resulting in a significant deviation from the original fiscal targets. According to Budget 2009, the overall budget deficit was expected to reduce to 5.9 per cent of GDP after grants. However, with the subsequent developments in the domestic as well as the external fronts, the budgetary estimates were revised, targeting an overall deficit of 7.0 per cent of GDP. During the first half of 2009, there was a severe strain on fiscal operations mainly due to the lower growth in government revenue as a result of the slowdown in domestic economic activity and the contraction of imports reflecting the adverse impact of the global economic crisis. Meanwhile, the intensified security situation, urgent RRR activities in the Northern and the Eastern provinces and increased interest payments, while continuing expenditure on the public investment programme, raised government expenditure. During the second half of the year, the positive impact of the ending of the conflict in May 2009 and the rebound in domestic economic activity in line with the gradual recovery in the global economy eased fiscal operations to some extent, with the overall budget deficit recording 9.8 per cent of GDP in 2009.The high deficit was a combined outcome of a shortfall in revenue, overrun in recurrent expenditure and increased expenditure on infrastructure projects. The government revenue was significantly below the targeted level. The total revenue as a percentage of GDP declined to 14.6 per cent in 2009 compared to 14.9 per cent in 2008 and 16.3 per cent in 2006. Meanwhile, total expenditure and net lending increased to 24.9 per cent of GDP, compared to that of 22.6 per cent in 2008 and 24.3 per cent in 2006. Recurrent expenditure increased significantly, as a percentage of GDP to 18.2 per cent from 16.9 per cent in 2008. Public investment increased to an encouraging level of 6.8 per cent of GDP in 2009 compared to 6.0 per cent in the previous year.In financing the deficit, the government raised more funds from domestic sources during the early part of 2009 and from foreign sources during the latter part of the year. The increased borrowing requirement and the tight liquidity conditions in the international capital markets led the government to depend heavily on domestic borrowings during first half of the year. However, the significant increase in foreign investments in government securities and the receipt of proceeds from the international sovereign bond during the second half of the year enabled the government to retire a large amount of Treasury bills held by CBSL. As a result, total borrowing from the banking sector declined to Rs. 49 billion by end 2009 compared to Rs. 189.6 billion at end July 2009. Total net domestic financing in 2009 amounted to 5 per cent of GDP while net foreign financing was 4.8 per cent of GDP, which consisted of foreign loans (1.8 per cent of GDP) and foreign investments in government securities (3.0 per cent of GDP). Meanwhile, the outstanding government debt to GDP ratio increased slightly to 86.2 per cent in 2009 mainly reflecting the higher budget deficit and the lower growth in nominal GDP.

Monetary Sector DevelopmentsCBSL relaxed its monetary policy stance in 2009 to support domestic economic activity. Accordingly, the Penal interest rate applicable on reverse repo transactions when participating institutions exceeded the maximum number of times they could access the reverse repo window, which was introduced in November 2007, was reduced gradually and harmonised with the Reverse Repo rate in May 2009. At the same time, restrictions on access to Central Bank’s repo and the reverse repo facilities were also removed, thus re-establishing the interest rate corridor. The Central Bank’s policy interest rates were also gradually reduced during the year: the Repo rate was reduced by 300 basis points to 7.50 per cent and the Reverse Repo rate was reduced by 225 basis points to 9.75 per cent. In addition, margin deposit requirements that were imposed to restrict the demand for credit for certain categories of vehicle and non-essential imports, were removed during the first half of the year, to ease credit conditions.CBSL took timely and appropriate measures to manage rupee liquidity in the market. The continued capital outflows during the first quarter of the year necessitated CBSL to supply foreign currency to the market resulting in a drain in rupee liquidity from the market. CBSL lowered the Statutory Reserve Ratio (SRR) by a further 75 basis points to 7 per cent in February 2009, following the reduction in the SRR imposed on all rupee deposits of commercial banks by 225 basis points in the last quarter of 2008 releasing about Rs.9 billion to the market. In addition, CBSL purchased Treasury bills from the primary market, while also engaging in reverse repo transactions to enhance rupee liquidity. CBSL also removed the restriction on access to reverse repo standing facility by market participants in 2009.However, since June 2009, there has been a turnaround in liquidity, posing a challenge to managing the surplus. Renewed investor confidence with the end to the conflict and the securing of the SBA facility from IMF substantially increased foreign investments in government securities from May 2009 onwards. The proceeds of these inflows were purchased by CBSL to stabilise the foreign exchange market and to build official reserves. The resulting increase in rupee liquidity in the market was absorbed through the Central Bank’s open market operations (OMO), thus leading to a significant reduction in the Central Bank’s holdings of government securities necessitating the use of alternative instruments to conduct OMO. Accordingly, Central Bank Securities were issued to absorb liquidity on overnight basis and term basis from October 2009. In addition, CBSL commenced foreign exchange swap transactions as an additional instrument for absorbing liquidity from November 2009. The targets for monetary aggregates, which were initially set out in the Monetary Programme for 2009 and announced in the Central Bank’s ‘Road Map: Monetary and Financial Sector Policies for 2009 and beyond’ (Road Map) were subsequently revised downward. The reduction in the SRR, the rapid decline in inflation and the slowdown in the domestic economy were the main factors that warranted this downward revision. Accordingly, the target for the growth in reserve money was revised downward from 5 per cent to 2.8 per cent, while that of broad money was lowered from 14 per cent to 13 per cent. Although the growth in reserve money contracted during the first three quarters of 2009 largely due to the lowering of SRR in the last quarter of 2008 and the first quarter of 2009, it began to increase in the last quarter of 2009, due to the increase in credit to the government from CBSL and the dissipation of the impact of the changes in SRR in the last quarter of 2008, on reserve money. Accordingly, the annual average growth in reserve money contracted by 0.7 per cent, which was within the target set in the revised Monetary Programme for 2009.  The growth in broad money, which moderated during the first half of the year, gathered pace thereafter, with annual average broad money growing by 13.6 per cent, which was marginally above the target set in the revised Monetary Programme for 2009.Interest rates across the term structure shifted downwards in line with the changes in the policy rates and the improvements in market liquidity. The average weighted call money rate (AWCMR) was brought within the policy interest rate corridor, improving the effectiveness of the Central Bank’s monetary policy operations. Other market interest rates also declined in line with these changes, although lending rates of commercial banks declined at a slower pace.

Financial System StabilityDuring 2009, the financial sector remained resilient and financial system stability was maintained despite challenging market conditions. Financial sector institutions were confronted with the stresses caused by the spill-over effects of the global financial crisis and the consequent decline in demand in the domestic economy which had an adverse impact on their business operations. As the global financial turmoil deepened and the global economy contracted, there was an outflow of foreign investments in government securities creating a liquidity shortage in money markets, although this situation turned around with the money market becoming liquid and the equity market rebounding after the end of the conflict in May 2009. The loss of investor confidence and liquidity constraints faced by several entities connected to banks and finance companies in the Ceylinco Group had an adverse impact on the finance and leasing sectors.However, swift and decisive actions taken by CBSL and the government contributed towards restoring public confidence and continued stability in the financial system. CBSL successfully resolved the liquidity problems encountered by Seylan Bank, a systemically important licensed commercial bank (LCBs), which was a part of the Ceylinco Group. Seylan Bank was recapitalised by issuing new shares and is currently carrying on normal business operations. With a view to resolving the liquidity constraints faced by distressed registered finance companies (RFCs) and specialised leasing companies (SLCs) in the Ceylinco Group, CBSL appointed managing agents and obtained the services of a panel of experts to advise and guide the recovery process. In addition, a special stimulus package and a guarantee scheme were put forward by CBSL with the support of the government to assist RFCs and SLCs that were experiencing liquidity problems. These measures were successful in facilitating the commencement of business operations and bringing stability to the sector.
OutlookThe end to the prolonged internal conflict and the restoration of peace provide a greater optimism for economic prosperity and a strong basis for long-term sustainable development, supported by appropriate policies. The opportunities created by the restoration of peace, will be complemented by the ongoing global economic recovery. The low inflation and interest rate regime that prevails also provides a conducive environment to fuel economic activities. To harness these opportunities, the existing bottlenecks that hinder a faster growth need to be addressed urgently. Infrastructure projects, already commenced and planned, need to be accelerated to expand the productive capacity of the economy and to improve the efficiency and productivity of economic activities. At the same time, special attention needs to be paid to implement much needed structural and institutional improvements, including the enhancement of the profitability and productivity of public enterprises that are a significant drain on public finances. The fiscal consolidation process also needs to be strengthened. The contribution of the private sector to overall economic development needs to be increased. The regulatory framework has to be further strengthened. Establishment of a strong development planning and monitoring process would be helpful to prioritise projects, avoid delays and ensure the optimal allocation of resources. In the short to medium-term, moving to a high growth trajectory, while maintaining price stability remains a key policy challenge.

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