51811 September, 2009 Sri Lanka Economic Update Economic Policy and Poverty Team South Asia Region The World Bank Sri Lanka Economic Update1 September 2009 Overview: From Global Gloom to Hopes of Peace Food, Fuel and Financial Crises: Sri Lanka has been buffeted by a series of shocks in the past year and a half. The rapid rise in global food and commodity prices during the first half of 2008 which led to a significant worsening of the Sri Lankan terms of trade. Rising international commodity prices also put significant strain on the balance of payments, with the current account deficit reaching 9.3 percent of GDP in 2008 ­ the highest in nearly 25 years. The price shocks also helped fuel consumer price inflation, which reached a peak of 28 percent in July 2008. The onset of the global economic and financial crisis in September 2008 resulted in a sudden outflow of foreign capital, especially foreign investors' holdings of government T-bills and T-bonds. The subsequent drain in foreign exchange reserves was exacerbated by the Central Bank's intervention in the foreign exchange market in an effort to limit the depreciation of the rupee against the US dollar. Gross Official Reserves dropped precipitously from US$3.4bn in mid-September to a low of US$1.2bn in mid-March 2009. The real sector also suffered, as real GDP growth fell to 4.3 percent, year-on-year, in Q4-2008 and declined further to 1.5% in Q1-2009, on the back of a moderation in both domestic and external demand. Sustaining the End-of-Conflict Dividend. The end of the nearly-three-decade-long armed conflict on May 19 brought a surge in optimism about the potential economic benefits of peace. The Colombo Stock Exchange surged 30 percent to end September 2009, while Sri Lanka's sovereign bond spreads narrowed by over 400 bps. Standard & Poors upgraded the country's rating outlook from "negative" to "stable" in August. Optimism was further boosted by the approval of the IMF Stand-By Arrangement in July. Capital has flowed into the economy in the form institutional investments into the Colombo bourse as well as foreign investments into government securities. As a result, foreign exchange reserves are at historical highs and there is pressure on the rupee to appreciate. Sustaining the positive investor sentiment will be a key challenge in the coming months. A still-weak global economy, concerns about the continuation of the preferential access for Sri Lankan exports to the EU market under the GSP+ scheme and persistently high fiscal deficits are risks to the outlook. On the other hand, reconstruction spending in the North is expected to provide a short-term stimulus, while the lagged effects of the recent monetary stimulus would also act as a fillip. In the longer term, movement towards a sustainable political solution to the underlying causes of the conflict will be key, as will decisive moves on the structural policy agenda to unleash Sri Lanka's full growth potential. 1 This is report was prepared by Claus Pram Astrup, Kirthisi Rajatha Wijeweera, and Francis Rowe. 1 1. Impact of the Global Financial Crisis Gradually Recedes Trade contracts, but terms of trade improve. As in many other countries, trade has been the primary channel through which the global crisis has been transmitted to Sri Lanka. From October 2008 to June 2009, real exports contracted by 5.2 percent while real imports contracted by more than twice that rate, at 12.4 percent. In line with rapidly contracting global demand, Sri Lankan import prices contracted by over 7 percent during the period. The fall in export prices was relatively less pronounced ­ 4.2 percent during the referenced period. Consequently, there was an improvement in the trade balance and in the country's terms of trade. Both trends reversed a course set during the global commodity price hike (Figure 1). Figure 1. Sri Lanka: Terms of Trade Figure 2. Sri Lanka: Trade Balance, Exports and Imports 115 40% $7,000 110 $6,000 30% 105 $5,000 20% 100 $4,000 95 10% $3,000 90 0% $2,000 2007m1 2007m7 2008m1 2008m7 2009m1 2009m7 85 -10% $1,000 80 2001m1 2001m7 2002m1 2002m7 2003m1 2003m7 2004m1 2004m7 2005m1 2005m7 2006m1 2006m7 2007m1 2007m7 2008m1 2008m7 2009m1 -20% $0 Rolling 12m Balance of Trade, (right axis) Import (% change, 12m-ma) Export (% change, 12m-ma) Source: Central Bank of Sri Lanka Source: Central Bank of Sri Lanka and World Bank staff calculations Remittances decelerated, but are holding steady: The other key channel through which the worldwide financial-economic crisis has affected Sri Lanka is through remittances, which are a key source of foreign exchange, at roughly 8 percent of GDP. Remittances have held up quite well during the crisis, increasing 5.4 percent, to US$1,586 million in the six months to June 2009, compared to US$1,505 million in the corresponding period in 2008. There is a rough correlation between the stock of migrant workers and remittances, with every 1,000 increase in the migrant workforce bringing additional revenue of US$1.7.million.While existing migrant stocks fell in destinations such as South Korea, the main migrant destination - the Middle East, which holds nearly 85 percent of the total migrant workforce remained steady. Initial data for the second half of 2009 indicate that remittances have accelerated post-conflict. 2 Inflation declined sharply: Having reached an Figure 3. Consumer Price Inflation historic peak in mid-2008, consumer price inflation eased considerably in the wake of the 30% global crisis. Inflation, which peaked at 28.2 percent (y-o-y) in June 2008, due to the global 25% food and commodity price shock, eased 20% considerably and fell to a low of 0.9 percent in 15% August. Food prices account for nearly 48 percent of the CPI basket and the representative 10% food basket has high import content. Food price 5% inflation turned negative towards April and remained at more-or-less subdued levels through 0% 2007m1 2007m7 2008m1 2008m7 2009m1 2009m7 August (recording 0.6 percent change y-o-y). Core inflation (excluding food and energy prices) Headline Inflation (yoy) Core inflation (yoy) also showed a less pronounced reduction over the period, easing to 6.4 percent (y-o-y) in August 2009, from a high of 18.7 percent in September 2008. Core inflation will require close Source: Department of Census and Statistics and Central Bank of Sri Lanka monitoring, given the significant monetary easing that has taken place in recent months. Box 1. Sri Lanka's Apparel Sector In contrast to many other export categories, exports of apparel and textiles - the single largest export item continued to grow during the first two quarters of the global financial crisis (i.e., Oct 08-March 09). Nominal exports of garments grew by 6.3 percent on the back of 5.4 percent growth in volumes. The increased volumes during the period were due mainly to the lagged effects of demand adjustment from buyers as well as, in part, to the aggressive marketing. Garment exporters were also incentivized by the stimulus measures announced in December 2008, which promised a cash premium to firms who could maintain employment/sales levels. However, during 2009, garment export volumes declined by 9.4 percent, as full impact of decline in demand was felt. The Sri Lanka apparel sector has been a major export earner as well as employment source for many decades. With the expiry of the Multi-Fiber Agreement (MFA) in 2005 (which afforded protection to the sector through quotas) the sector has been exposed to increased competition. However, the sector weathered the end of the MFA well by strategically positioning itself through (i) establishing niche markets with solid client networks; (ii) effective backward and forward integration through establishment of fabric manufacturing plants as well as moving into fashion design and vendor inventory management, and; (iii) adopting world standards in labor, safety and environmental compliance (branded "garments without guilt"). Box continued next page 3 The transition to the post-MFA situation was also Figure 4: Garment export to EU and US, US$ million eased by the fact that soon after the tsunami in 1,800 December 2004, the country was granted preferential 1,600 access to the EU markets through the GSP+ scheme. (The GSP+ scheme allows duty free access to the EU 1,400 for some 7,200 products. While initially granted to a 1,200 large extent in view of the Tsunami, a country's access 1,000 to the GSP+ scheme is dependent on adherence to a 800 large number of international conventions.) The GSP+ scheme accelerated an already existing trend of 600 increasing garment export to the EU. By 2008, EU 400 became Sri Lanka's biggest export destination for 200 garments, surpassing the U.S.A. 0 1995 1997 1999 2001 2003 2005 2007 Concerns have arisen over the extension of the GSP+ US EU concessions beyond 2009. Currently, the EU is considering an extension taking account of industrial Source: Central Bank of Sri Lanka standards as well as overall political and governance developments in partner countries. A final determination in this regard is expected to be made in October and formally announced in December 2009. Economic growth down, but not out: Economic activity decelerated sharply at the onset of the global financial crisis. The decline was particularly pronounced in the industry and services sectors, while the agriculture sector showed strong growth, buoyed by one-off supply-side effects. National Accounts data for Q2-2009 show a modest uptick in growth to 2.1 percent from 1.5 percent in Q1-09. Figure 5. Real GDP Growth Figure 6. Real GDP Growth in Main Sectors 8% 14% 7% 12% 6% 10% 5% 8% 4% 6% 3% 4% 2% 2% 1% 0% 0% 2007q1 2007q2 2007q3 2007q4 2008q1 2008q2 2008q3 2008q4 2009q1 2009q2 2003q1 2004q1 2005q1 2006q1 2007q1 2008q1 2009q1 Agriculture Industry Services Source: Department of Census and Statistics Source: Department of Census and Statistics 4 The service sector initially was impacted more Figure 7. Container Throughput, TEU, % change yoy rapidly and more heavily than industry, due to 15% the importance of trade services in GDP, including the large volume of transshipments 10% handled in the Colombo Port. The service 5% sector dropped 0.6 percent (q-o-q, seasonally 0% adjusted) in Q4-2008 and a further 1.4 percent 1/2008 2/2008 3/2008 4/2008 5/2008 6/2008 7/2008 8/2008 9/2008 10/2008 12/2008 1/2009 2/2009 3/2009 4/2009 5/2009 6/2009 11/2008 -5% (q-o-q, seasonally adjusted) in Q1-2009. Services related to foreign trade dropped more -10% than twice as fast, on an annualized rate, as the -15% overall service sector. Ports data show that in -20% Q2-2009 volumes dropped to about 15 percent below their long-term trend level, but the pace -25% of decline was abating, as activity picked up up -30% 2 in May and June. Overall, the service sector rebounded in Q2-2009, as growth momentum Source: Central Bank of Sri Lanka. Note: "Domestic" throughput only, i.e. excluding turned positive to reach 2.2 percent (q-o-q, transshipments. seasonally adjusted). The rebound was evident across a number of service sectors, including banking, telecom, domestic trade, and government services. Recent industrial production data points to a Figure 8. Industrial Production Index, % change (yoy) rebound in Q2-2009. Industrial production increased 3.76 percent (q-o-q, seasonally 14% adjusted) in Q2-2009 following a drop of 3.6 12% percent (q-o-q, seasonally adjusted) in Q1- 10% 20093. The rebound was driven by 8% domestically-oriented industries (e.g., food production and construction) while the more 6% export oriented textile and apparel industries 4% cut back production in response to weak global 2% demand. However, the most recent data (June) 0% showed a sharp rebound in apparel production. 1/2008 2/2008 3/2008 4/2008 5/2008 6/2008 7/2008 8/2008 9/2008 10/2008 12/2008 1/2009 2/2009 3/2009 4/2009 5/2009 6/2009 11/2008 -2% -4% Source: Central Bank of Sri Lanka 2 Data for shipments through Colombo port show that import and export shipments during Q2-2009 remained depressed (a decline of 5.9 percent, q-o-q). However, transshipments grew by 12.1 percent (q-o-q) reflecting a gradual rebound in world trade. 3 Due to the relatively short time span for which quarterly GDP data is available, estimates of seasonally-adjusted data are subject to a degree of uncertainty. 5 In agriculture, lack of rainfall is expected to Figure 9. Tea Production, % change (yoy) reverse recent supply-side gains for the remainder of 2009. Agricultural production has 60% been boosted over the past year by positive supply-side effects from the expansion in 40% cultivable paddy land in the Eastern Province (on a y-o-y basis, total paddy production 20% increased by 50 percent in Q4-2008), and a 0% related boom in vegetable production. The 1/2008 2/2008 3/2008 4/2008 5/2008 6/2008 7/2008 8/2008 9/2008 10/2008 12/2008 1/2009 2/2009 3/2009 4/2009 5/2009 6/2009 7/2009 11/2008 effect of this one-off event is now wearing off, -20% although the 2009 spring (Maha) harvest was still up 12 percent compared to the 2008 Maha -40% harvest. This was due in large part to an increase in the area of cultivated land, resulting -60% in a 10 percent (y-o-y) real growth in Q1-2009 in the paddy sector. Preliminary estimates by Source: Central Bank of Sri Lanka the Department of Census and Statistics suggest that the 2009 Yala harvest will be some 30 percent lower than in 20084. 2. The Macroeconomic Response Monetary policy responds flexibly to crisis: Figure 10. Short term interest rates Monetary policy in Sri Lanka has eased significantly in the wake of the global financial 20% crisis. Prior to the crisis, monetary policy was 18% gradually tightened in response to rapidly 16% increasing consumer price inflation, driven in large part by rising commodity prices. Policy 14% easing which commenced in late 2008 12% continued into 2009. In 2009 to date, the benchmark interest rates of Repurchase (REPO) 10% and the Reverse Repurchase (RREPO) rates 8% were lowered by 225bps and 125bps, while the 25.06.2008 08.08.2008 22.09.2008 23.12.2008 10.02.2009 26.03.2009 15.05.2009 29.06.2009 24.09.2009 06.11.2008 11.08.2009 hitherto applicable "penal rate" on RREPO (applicable to banks which access the Central Call rate Reverse Repo Repo Bank of Sri Lanka RREPO window more than Source: Central Bank of Sri Lanka three times a month) was successively lowered, Note: Reverse Repo includes the "penal rate" and eliminated altogether in May. In addition, 4 The Yala harvest normally only account for 30-40 percent of total annual production. If current projections are correct, total annual paddy production in 2009 will be about 8 percent lower than in 2008. 6 the Statutory Reserve Requirement of commercial banks was cut twice in the last quarter of 2008 and lowered again in February 2009. Monetary policy effectiveness a question: As with many other countries, aggressive easing of monetary policy has not led to greater credit expansion. In the early part of the year, sizable intervention by the Central Bank of Sri Lanka to defend the rupee in the face of considerable foreign exchange outflows drained liquidity in the system, while a cautious attitude of banks in light of rising non-performing advances also limited credit expansion. However, in mid-March, the central bank halted its intervention, and allowed the rupee to depreciate. The drain in liquidity was arrested, but the banks remained cautious about lending. Total private sector credit recorded its sixth successive month-to-month contraction in June - falling by an annualized 10.3 percent from December 2008. Post-May 2009, prime lending rates have begun to fall more rapidly (over 480 bps to August) in face of the rapidly expanding liquidity and falling deposit rates, but credit remains slow to recover. Central Bank Intervention - A reversal of fortunes: The Central Bank of Sri Lanka's defense of the rupee precipitated a decline in foreign exchange reserves to very low levels and led to an appreciating real exchange rate. However, since the central bank halted interventions in mid-march, the situation has rapidly reversed. Gross official reserves topped US$ 4 billion in mid September ­ a record high, and equivalent to more than four months worth of import. The reversal was helped by the significant decline in the trade deficit and the sustained inflows of remittances, which together implied that the current account deficit narrowed considerably in the first half of 2009. Initial estimates indicate that the current account deficit recorded a surplus of US$129 million in the first half ­ a significant improvement from the 25-year high deficit recorded by end 2008. Moreover, the capital account was buoyed by very strong post-conflict capital inflows from foreign equity investments and investments into government securities. As much as US$1.2 billion flowed into T-bills and bonds in the space of three months. Inflows were further boosted by the disbursement of the first tranche of the IMF's Stand-By Arrangement in late-July (US$320 million), as well as the release of US$475 million (special drawing rights (SDR): US$306.5 million) from the IMF general allocation undertaken in late August.5 The upcoming US$500 million sovereign bond issues, planned for October 2009, will further add to capital inflows. When the central bank halted intervention in mid- March, the rupee depreciated to an historic low of Rs 120/US$. Since then the rupee has appreciated as import demand has slowed and capital inflows have accelerated. The central bank is now purchasing foreign exchange, and the rupee had strengthened to slightly below Rs 115/US$. 5 In early September, a further US$33 million (SDR: US$18.1 million) was realized through the special SDR allocation provided under the Fourth Amendment of the Articles of Agreement (effective on 09 September). 7 Figure 11. Exchange Rate, Rs/US$ Figure 12. Gross Official Reserves, US$ mill. $4,500 122 $4,000 $3,500 120 $3,000 118 $2,500 116 $2,000 $1,500 114 $1,000 112 $500 110 $0 12/17/08 1/26/09 2/13/09 3/25/09 4/14/09 5/22/09 7/21/09 8/10/09 8/28/09 9/17/09 1/6/09 3/5/09 5/4/09 6/11/09 7/1/09 2008m8 2008m10 2008m12 2009m2 2009m4 2009m6 2009m8 Source: Bloomberg Source: Central Bank of Sri Lanka Limited fiscal space to respond to the crisis: Figure 13. PreCrisis macro vulnerability Persistent fiscal deficits in recent years (on average, 7 percent of GDP) meant that Sri Figure 1. Macro Vulnerability Pre-Crisis Lanka entered the crisis with little fiscal space 25% to address declining domestic demand. The Cumulative Fiscal Balance (% of 2007 GDP) 20% Chile Government did, however, introduce a modest 15% Bulgaria fiscal stimulus package, amounting to 0.3 10% percent of GDP in early 2009. The package, a 5% China further moderating of revenues in the first half 0% -5% of 2009 and recurrent expenditure recording Lao PDR -10% overruns, was putting the 2009 fiscal deficit on -15% Maldives Jordan Malaysia track to exceed 9 percent of GDP. Recognizing -20% Sri Lanka that a fiscal deficit of this magnitude would -25% -100% -80% -60% -40% -20% 0% 20% 40% 60% exacerbate macroeconomic imbalances, a key Cumulative Current Account Balance (% of 2007 GDP) component of the Government's commitment under the IMF program is to see the fiscal Source: Department of Census and Statistics and Central Bank deficit contained to 7 percent of GDP in 2009. of Sri Lanka Reaching this target will require both expenditure restraint and buoyancy of revenues. Data for the first six months of the year show a deficit of nearly 12 percent of GDP. Over the same period, public spending has increased by 17 percent to 25 percent of GDP compared to close to 23 percent of GDP in the first half of 2008. The increase in expenditure is mainly due to strong increases in defense, pensions, and interest payments. To meet IMF program targets, total expenditure will have to be contained to 19 percent of GDP in the second half with recurrent expenditure taking the brunt of the adjustment. The revenues outturn in the first half of the year indicates a continuation of the decline, with the revenue-to-GDP ratio dropping to 13.1 percent, compared to 15.1 percent in the first half of 2008. A 8 key driver of the decline has been falling revenues from trade and trade-related taxes6, which comprises the bulk of government tax revenue. Preliminary data indicate that revenue increased sharply in July and August. Continued strong performance will be needed to meet year-end targets. Table 1. Fiscal Performance through June 2009, Full-year Actual Turnout Avg. per Balance req. to Avg. per targets 1H09 month 1H09 reach targets month to reach Rs Bn 2H09 targets 2H09 Revenue 725 290 48 435 73 Tax 658 266 44 392 65 Non Tax 67 23 4 43 7 Expenditure 1,076 553 92 523 87 Current 811 433 72 378 63 Capital 265 120 20 145 24 Deficit 351 263 44 88 15 Source: Central Bank of Sri Lanka An important motivation for the fiscal Figure 14. Debt sustainability scenarios consolidation effort has been concern over debt sustainability. Sri Lanka's stock of public debt Baseline Most extreme shock Fix Primary Balance Historical has nearly doubled since 2000, mainly as a 100 result of financing persistent primary fiscal 90 PVof Debt-to-GDPRatio deficits. The government has relied on both 80 external and domestic sources of financing in 70 60 roughly equal measures until recently, when it 50 had to rely more heavily on domestic debt 40 issuance (to Banks), particularly in late 2008 30 and most of 2009, when international capital 20 10 markets were all but closed. While robust GDP 0 growth and a real appreciation of the rupee has 2008 2009 2010 2011 2012 2013 2014 2015 2016 2017 2018 2019 2020 2021 2022 2023 2024 2025 2026 2027 2028 led to a decline in the debt-to-GDP ratio from 98 percent in 2005 to 87 percent in 2008, the structure of the debt portfolio has changed in Source: World Bank and IMF staff estimates ways that have increased both its costs and risks. There has been a shift away from lower-cost external concessional borrowing to higher-cost domestic and non-concessional external borrowing. Domestic interest costs are estimated to be over 30 percent of government expenditures in 2009. Moreover, more than 40 percent of the domestic debt stock will be maturing in 2009, indicating significant roll-over risk. The recent joint Bank-Fund debt sustainability analysis indicates that the country is at a moderate risk of debt distress, with this conclusion resting heavily on the satisfactory implementation of fiscal consolidation measures. 6 Such as VAT and the Nation-Building Tax 9 3. PostConflict Prospects Strong domestic demand has been main Figure 15. Demand component's contribution to growth driver of growth in recent years. Sustained growth in consumption, and to a certain extent 10% in investments, has been the key driver of 8% growth in the past 3-4 years. Total 6% consumption makes up about 80 percent of 4% GDP and has grown at an average annual rate 2% of 6.5 percent from 2005 to 2008. Growth in public consumption was particularly strong, at 0% an average annual rate of 8.9 percent. The rise -2% 2004 2005 2006 2007 2008 2009 in public consumption was due mainly to an -4% increasing in the public sector payroll, which Consumption Investments increased by some 300,000 persons from 2005 Net Exports Total GDP to 2008. Private consumption grew by an average of 6 percent during this period. Total Source: Department of Census and Statistics and World Bank fixed investments increased by an annual rate Staff Calculations of 9.1 percent from 2005 to 2008. Growth in private investments gradually tapered off during the period to only 3.9 percent in 2008, as credit was gradually tightened and global economic prospects dimmed. Public investments have remained high, reflecting the government's commitment to improve public infrastructure - the average annual growth in public investments was 13.1 percent from 2005 to 2008. Net exports have made only a modest contribution to growth over the period. After the 2001/2 recession, the output gap Figure 16. Output gap (% of GDP) gradually closed to become positive from 2006. In the period leading up to the global financial 3% crisis, demand outpaced supply in the Sri 2% Lankan economy, placing pressures on prices and the external account. Real GDP growth 1% averaged 6.8 percent from 2005 to 2008. 0% Measures of the output gap- (the difference 2001 2002 2003 2004 2005 2006 2007 2008 2009 between actual GDP and "potential" GDP) -1% 7 suggest that the Sri Lankan economy has -2% operated above its potential since 2006. An accommodative monetary policy stance, an -3% expansionary fiscal policy, a favorable global -4% environment in terms of both export demand and international capital flows, all fuelled growth. Reconstruction spending in the wake Source: World Bank staff estimates of the 2004 tsunami also boosted domestic 7 We calculate "Potential GDP" by detrending actual GDP, using the Hodrick-Prescott Filter. 10 demand. By 2008, the output gap was positive (+2.3% of GDP), but the decline in growth expected for 2009 because of the global downturn should almost eliminate the positive output gap. This suggests that a more neutral macroeconomic policy stance should be pursued in 2009, in comparison to 2008 when a tighter policy was called for. In the short-to-medium term, prospects for the Figure 17.Consensus Export Market Growth, % Sri Lankan economy look positive. First, 5 Forecast 4 there are increasing signs that the global 3 economic crisis is bottoming out. Prospects of 2 a global recovery would provide enhanced 1 growth impetus through recovery in exports, 0 increase in tourism and possible greater FDI -1 inflow8 . Recovery in exports, however, would -2 -3 be contingent on a number of other outcomes -4 Q1-01 Q3-01 Q1-02 Q3-02 Q1-03 Q3-03 Q1-04 Q3-04 Q1-05 Q3-05 Q1-06 Q3-06 Q1-07 Q3-07 Q1-08 Q3-08 Q1-09 Q3-09 Q1-10 Q3-10 (e.g., the GSP+ concessions). In a low- inflation environment, the REER can be Export partner weighted GDP growth expected to support export competitiveness. Consensus forecast - September 2009 survey The tourism sector is already showing signs of Consensus forecast - March 2009 survey reaping the end-of-conflict dividend, with July Source: Consensus Economics, IMF and World Bank and August arrivals having risen substantially. However, prospects for enhanced FDI inflow would depend on an improvement in the overall investment climate, the elimination of the security threat, the improvement in debt sustainability prospects and the continuation of a low inflation environment. The end of the armed conflict has inevitably shifted attention to reconstruction efforts. These would provide further growth impetus, at least in the next year or two. Although fiscal constraints may put some limit on reconstruction spending, it is expected that there will be an uptick in remittance inflows to fund household-level reconstruction efforts (e.g., housing). With the gradual resettlement of the displaced and restoration of livelihood, agriculture and SME production is expected to pick up. Domestic banks are seeking opportunities in the North and East, indicated by 67 applications for new branches received by the central bank in May. Private investments in general would also be expected to pick up into 2010 in response to lower interest rates. Overall, growth in 2009 is expected to be in the 3-4 percent range, and to accelerate to above 5 percent in 2010. However, as noted there are several downside risks to these projections, particularly in the event of a slow and anemic recovery in the global economy and other exogenous factors such as the cancellation of the GSP+ concessions. 8 However, this will depend to a large extent on the measures the country would undertake to improve its investment climate. 11 Table 2. Selected Macroeconomic indicators Real Growth, % 2004 2005 2006 2007 2008 2009 GDP 5.4% 6.2% 7.7% 6.8% 6.0% 3.6% Consumption 4.1% 3.3% 7.1% 4.5% 8.0% 3.5% -- Private 3.3% 1.7% 6.5% 3.9% 7.6% 3.0% -- Public 9.3% 12.0% 9.6% 7.4% 9.8% 6.0% Gross Domestic Fixed Capital Formation 17.8% 9.8% 12.9% 9.1% 5.3% 4.6% -- Private 19.9% 0.7% 15.4% 5.4% 3.9% 3.0% -- Government 3.7% 81.9% 2.0% 27.6% 11.1% 7.5% Net Exports 13.6% -10.9% 19.6% -9.0% 21.7% 0.0% -- Export of Goods and Services 7.7% 6.6% 3.8% 7.3% 0.4% -5.0% -- Imports of Goods and Services 9.0% 2.7% 6.9% 3.7% 4.5% -3.0% Memorandum Items GDP US$ bn. 20.7 24.4 28.3 32.6 40.7 42.9 Current account, % of GDP -3.1% -2.7% -5.3% -4.2% -9.3% -1.2% Source: Department of Census and Statistics and World Bank staff calculations Preliminary estimates suggest that Table 3. Results from Growth Accounting Sri Lanka's long-term potential Real GDP Growth Contribution from: growth rate is around 6 percent. %, p.a. Capital Labor TFP 1960s 4.2% 1.4% 2.0% 0.7% The post-conflict boom may help 1970s 3.8% 2.6% 1.8% -0.5% Sri Lanka to return relatively 1980s 3.5% 3.0% 1.4% -0.8% rapidly to growth rates in this 1990s 4.6% 2.0% 1.3% 1.3% range, but is unlikely to 2000s*/ 5.1% 2.1% 1.3% 1.7% significantly increase the long- Source: World Bank Staff Calculations term potential growth rate, unless a Note: Estimate for 2000s exclude 2001 significant structural policy agenda is implemented. From a simple growth accounting perspective9, there is a need to increase overall investment rates to expand the stock of productive capital. This would require significant increases in domestic savings rates, which, after hovering above 17 percent of GDP between 2005 and 2007, dropped to just over 14 percent in 2008. Human-capital accumulation also needs to be accelerated, which, given that Sri Lanka is already well into its demographic transition, implies that the quality of labor must be improved. Finally, total factor productivity (TFP), a measure that aims to capture structural improvements affecting the efficiency of use of existing production factors, remains rather low in Sri Lanka, although the reforms of the 1990s seem to have increased TFP growth in the last decade. 9 Assuming Cobb-Douglas technology, and parameters as PREMnote 42. 12 WORLD BANK ASSISTANCE TO SRI LANKA IN FY10 IDA Million Product Name US$ Current Status LENDING Second Community Development and Livelihood 75 Approved on Sept. XX Improvement Project Northern Emergency Rehabilitation Project 65 Preparation Provincial Roads Project 105 Preparation Sustainable Tourism Project 20 Preparation North and East Services Improvement Project 78 Preparation Eco-system Conservation Management Project 20 Preparation Higher Education Project 40 Preparation AAA "Towers of Learning"--Higher Education Report Released in July 2009 "Connecting People to Prosperity" ­ Economic Report Preparation Country Environmental Analysis Preparation Infrastructure Assessment Preparation Health Service Delivery System Report Preparation 13