Cablegate: Continued Improvement in Sri Lanka?S Growth,

This record is a partial extract of the original cable. The full text of the original cable is not available.

UNCLAS SECTION 01 OF 02 COLOMBO 001812

SIPDIS

SENSITIVE

STATE FOR SA/INS M. GOWER, AND C. SIM; MCC FOR D. NASSIRY
AND E. BURKE

E.O 12958: N/A
TAGS: ECON EFIN CE
SUBJECT: CONTINUED IMPROVEMENT IN SRI LANKA?S GROWTH,
DESPITE INFLATION, VIOLENCE AND UPCOMING ELECTIONS

Ref: Colombo 1492

1. (U) Summary: Since the last economic update (reftel),
the Central Bank of Sri Lanka has released second quarter
GDP data which shows a 6 percent annualized growth rate in
the second quarter. The growth rate for the first half of
2005 is estimated at 5.1 percent. Exports have also been a
strong contributor to growth. The Central Bank expects the
economy to post a growth rate of 5 to 5.5 percent in 2005,
in line with post tsunami forecasts. However, fiscal and
monetary developments need to be watched during the rest of
the year. Government fiscal control will be difficult this
year, given high oil prices, continuing subsidies, tsunami
reconstruction and populist programs on the eve of the
budget and presidential elections. Inflation remains a
major cause for concern. Garment exporters expect continued
growth in the wake of US safeguards on China, but worry about
the post-2008 removal of safeguards. Upcoming presidential
elections present the populace with a fairly distinct choice
on the country's economic policies. End Summary

2. (U) Sri Lanka?s economy grew by 6 percent in the second
quarter, recovering strongly from the tsunami damage.
Growth came mainly from service and manufacturing sectors,
while performance in the agriculture sector was mixed as
the tsunami-damaged fisheries sector declined. In the
services sector, telecommunications, ports and aviation
continued to contribute strongly to growth. The
manufacturing sector grew 6.5 percent aided by strong
exports. The construction sector expanded 5.8 percent
boosted by tsunami reconstruction and other infrastructure
projects. In the agricultural sector, tea, rubber and
paddy production recorded strong growth rates. According
to the Central Bank, paddy production has increased by 20
percent in the main ?Maha? cultivation season to a new
record level. These trends are expected to continue in the
second half, with all sectors contributing to growth.

3. (U) On the external front, according to latest data,
exports have increased by about 13 percent in the first
eight months of the year, the result of continued growth in
the garment sector. Imports grew by 11.3 percent during
this period (primarily the result of increased oil prices).
The trade deficit rose 7.7 percent to USD 1.6 billion. The
Balance of Payments recorded a surplus of around USD 190
million for the first eight months as the higher trade
deficit was offset by higher worker remittances (up 22
percent), official aid, and debt relief. According to
official data, tourist arrivals have increased 4.6 percent
through August. Most of those arrivals consist of business
travelers, transit visitors, and tsunami relief workers,
however, prompting resort owners to complain of low
occupancy in the tourism hotel sector. Income from port
services has also remained strong. Gross official reserves
at USD 1.24 billion in August 2005 were sufficient to cover
3.3 months of imports.

4. (U) However, fiscal and monetary aggregates have
deteriorated. Sri Lanka's inflation rate touched 12.7
percent in September and money supply increased
significantly. Money supply growth continues at around
20 percent, mainly due to an increase in both public
and private sector credit. The IMF expects inflation
to rise further this year, as aid inflows for tsunami
reconstruction and oil prices boost inflationary pressures.
The Central Bank and the Treasury disagree and the Central
Bank kept interest rates unchanged in October, hoping
earlier rate hikes (150 basis point since November 2004)
would help to gradually curb monetary expansion and tame
inflationary expectations. Currently, the Central Bank
repurchase rate and reverse repurchase rates are at 8.5
percent and 10 percent respectively. The bank intends to
conduct more aggressive open market operations to control
monetary and credit expansion.

5. (SBU) The government will present its FY 2006 budget to
Parliament on November 8. While the opposition has asked
the government to wait and allow the new President to
pursue his own agenda, the Government is likely to present
the budget as planned. Treasury Secretary P.B. Jayasundera
told the Ambassador recently that he had asked the Attorney
General about the possibility of deferring the budget
presentation until after the elections. The AG reportedly
told P.B. that since the Government remains in power until
the elections, and since Parliament continues to sit, the
Government should present a budget. The budget could give
the Government the opportunity to highlight the Prime
Minister?s Presidential Election Manifesto, which will
reportedly include continued subsidies for the agricultural
sector, increased government employment opportunities and
expanded welfare benefits, but it will also have to balance
those promises against its efforts to keep fiscal
discipline, tame inflation and pursue a sovereign rating.

6. (U) The 2006 budget will also give an indication of the
final fiscal outcome in 2005. The Government targeted a
deficit of 7.5 percent of GDP in 2005. Since then,
official projections have been revised to a deficit of 8.2
percent to accommodate tsunami expenditure. The broader
public sector deficit would be larger if losses in state
enterprises, especially the state owned petroleum and
electrical utility, are counted.

7. (U) In September, the government obtained parliamentary
approval for a supplementary budget estimate of Rs. 58.6
billion (USD 586 million) to finance additional expenditure
on tsunami related development work in 2005. Part of the
expenditure is being funded through foreign aid and the
balance through government funds. The government also
plans to raise USD 100 million through an international
bond issue opened to its expatriate work force
(approximately one million Sri Lankans live and work
abroad) in November. These funds will be used to finance
key infrastructure projects.

8. (SBU) Comment: While inflation remains a key concern,
the economy?s growth remains remarkably buoyant, given the
uncertainty surrounding the presidential elections and
recent events that have called into question the strength
of the ceasefire with the Tamil Tigers. We have heard from
garment manufacturers that continued growth is likely, so
long as the US continues to maintain safeguards on Chinese
textile and apparel products, yet there is much hand-
wringing in the industry about what happens after 2008
(when the US agreement with China on China?s WTO accession
removes the safeguard provision). The electorate in Sri
Lanka faces a fairly distinct choice between the two
candidates in the upcoming elections, and despite lots of
populist promises on both sides, one side (the opposition
United National Party) clearly favors a private-sector
driven market approach, while the Sri Lanka Freedom Party
candidate, Prime Minister Mahinda Rajapakse, favors more
government intervention and direction in the economy. We
will report on the two campaigns? economic programs septel,
but we expect both to promise significant benefits
(subsidies, price controls, etc) without much explanation
of either related budget cuts, or significant revenue
enhancements. End Comment
LUNSTEAD

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