This article gives a macroeconomic overview of the Sri Lankan economy.
Being a small open economy with a high degree of trade dependence, Sri Lanka was always going to be vulnerable to an external economic shock of the magnitude of the current global economic crisis.
The bulk of Sri Lanka’s exports are destined for the United States and the EU (63% of export value goes to the US and EU), the two regions most adversely affected by the economic crisis. Around 40% of Sri Lanka’s exports are from the garment sector (95% of which go the Europe and the US) and as a result Sri Lanka’s garment exports have declined in the recent years.
Tea export earnings have also been adversely affected by declining demand in the major markets which have driven prices down. The rubber and rubber products export sector has also been adversely affected by the global downturn. Other export sectors such as ceramics, gems and service exports (tourism and port services) have also been adversely affected by the global downturn.
The key challenge facing Sri Lanka and most countries in an integrated global economy is the contraction of export markets and freezing of external finance as a result of the global economic crisis.
Whilst the external economic crisis has adversely affected Sri Lanka’s economic performance, it has been coupled with a home grown downturn as well. In order to curb inflation that was prevalent in 2007 and 2008, the Central Bank drastically contracted monetary growth and reserve money growth fell. As liquidity shrank interest rates increased, resulting in a slowdown of the economy as investment and consumption declined. Higher interest rates also contributed to increased defaults and non-performing loans, resulting in a weakened financial sector. The economic slowdown was reflected in the weak performance across various sectors, particularly that of the services sector.
The fiscal situation continues to be a challenge as current expenditure exceeded current revenue in the recent years and the budget deficit was 7.7% of Gross Domestic Product (GDP) in 2008.
Furthermore, the economic downturn continues to put pressure on government revenue as import revenue has declined due to the slowdown in imports. The ability to finance the budget deficit has also been undermined by the freezing up of external financial markets, forcing greater domestic borrowing which could crowd out domestic financial markets.
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