Sri Lankan economy suffers as war continues

The ever increasing military expenses from the long dragging war combined with poor economic policies and record commodity prices has hit the already teetering Sri Lankan economy hard.

Recently released figures show the Gross Domestic Product (GDP) falling whilst inflation continuing to rise to record levels. Government budget deficit widened as the cost of defence, oil and food rose sharply whilst share holders pulled out of the fledgling stock market and tourists cancelled trips to the island.

Record inflation

Consumer prices in Sri Lanka hit 26.2% in May from a year earlier, after increasing 25 percent in April, on higher food and energy costs. According to HSBC Global Research, Sri Lanka has the highest annual inflation in Asia

“Even by its own history, inflation in Sri Lanka is on the high side.” the international bank said in a report titled ‘Sri Lanka Inflation: How high will it go?’ published on May 15.

Whilst the report said a large part of the increase in inflation can be explained by surging global commodity prices as Sri Lanka is a net importer of food and oil, it also blamed poor economic management the island’s economic woes.

Pointing to a history of high inflation, averaging around 11% year-on-year since 1990 the report suggested that policy management has not been consistently successful in controlling price pressures in the economy.

The report further added that “inflation is going to remain elevated for some time,” and any fall will only materialize in the second half of 2009, provided international commodity prices level off and “the Central Bank of Sri Lanka achieves its aggressive reserve money growth targets for 2008.”

Budget deficit

The record inflation is driven by food and energy costs.

Sri Lanka has been struggling to pay high global oil prices, which have hit levels above $145 this month compared with the island's 2008 budget estimate of $85 per barrel.

The Central Bank of Sri Lanka (CBSL) this week said the oil price alone would increase the country's trade deficit by $500 million to $4.47 billion this year.

"The overall deficit increased to 93.4 billion rupees ($867.4 million) from 74.3 billion rupees due to increased public investments," the treasury said in the report.

The treasury report further added the deficit from its operating activities in the first five months had surged to 23.4 billion rupees ($217.3 million) from last year's 11.62 billion rupees.

"The main reason for the deviation was the shortfall of revenue receipts," it said

In addition to the sky high commodity prices, the spiraling defence expenses have also taken a toll on the Sri Lankan economy.  The government allocated around 18 percent of its 925.1 billion rupees budget this year to defence spending, after quitting an internationally brokered ceasefire and pledging to destroy the LTTE.

Sri Lanka's economic outlook ``depends critically'' on an end to the island's 25-year civil war, according to the International Monetary Fund.

GDP growth slows

The growth in Gross Domestic Product also dropped by 1.4% to 6.2% in the first quarter compared with 7.6 percent in the fourth quarter, less than the median forecast of 6.4 percent in a Bloomberg News survey of 10 economists.

``Growth is slowing due to the impacts of the worsening security situation on business confidence and high inflation increasing costs for companies,'' said Vajira Premawardhana, head of research at Lanka Orix Securities Pvt. in Colombo.

Poor Rating

There was further bad news for Sri Lanka from credit rating agencies as Standard and Poor's warned last month it was at risk of a downgrade from its current B+ rating, while Fitch Ratings said it was concerned over Sri Lanka's increasing foreign commercial borrowings.

The government's external debt totaled $15.3 billion at the end of May, a $180 million increase from end 2007, the report showed, while its total debt rose to 3,328.8 billion rupees by the end of April, up 18.1 percent from a year earlier.

"The government should curtail its spending," said Chirantha Caldera, a currency dealer at Commercial Bank of Ceylon.

"If your revenue is coming down, and your defence expenditure is escalating, then curtailing spending on capital expenditure like infrastructure should be there," Caldera said, adding the government risked further stoking inflation which was running at an annual 28.2 percent in June.

Shares fall

Sri Lankan shares saw their a ninth consecutive fall last week as worries about the economy and a long-running civil war with Tamil Tigers kept investors out of the market.

The Colombo All-Share index fell 3.37 points to 2,401.17, its lowest close since January 21. The market has fallen 10.8 percent from an 11-month high on April 23.

"Economic and war worries are the main reason for the fall," said Hussain Ghani, assistant director at Asia Securities.

"Investors are waiting for a market-pushing news, but unfortunately nothing has happened. If this situation continues, even better corporate results for the last quarter will also not boost the market."

Sentiment on the corporate sector has been hit by poor economic data.

Fall in tourism

Sri Lanka attracted fewer holidaymakers in June, the island's main tourism promotion authority said Friday, blaming the drop in the number of visitors on the country's ongoing ethnic conflict

Arrivals in June fell 9.3 percent to 27,960 from 30,810 reported a year earlier and totalled 224,363 in the first half of 2008, down 0.2 percent from the same period a year earlier, Sri Lanka Tourism said.

The number of visitors from Britain and Germany -- both key markets -- fell five percent each in June to 5,304 and 1,317 respectively over the same period a year earlier.

The number of leisure travellers from neighbouring India declined 28.8 percent in June to 5,664, as against the same period last year.

"It's the conflict that is keeping tourists away. There are frequent bomb attacks and it is natural they would be cautious to travel here," an official from the tourism authority said.

Many countries in the west have cautioned their nationals against travelling to Sri Lanka, where fighting between government troops and Tamil Tigers has escalated since the start of the year.

Tourism is the fourth biggest revenue generator for Sri Lanka's 27-billion-dollar economy, behind remittances from expatriate workers, clothing and tea exports.