July 15, 2005
This statement reports on recent developments since the issuance of the staff report. The information presented does not materially change the economic outlook or the staff appraisal.
The political situation remains difficult. Despite the government's lack of majority in parliament, the President has ruled out calling for parliamentary elections at this time. Meanwhile, the main opposition party has stepped up its demand that a Presidential election be held this year.
The Post-Tsunami Operations Management Structure (P-TOMS), which was discussed in Parliament earlier this month, is taking shape. The P-TOMS will have representatives from the government, the LTTE and the Muslim community, and will be in charge of approving reconstruction projects for tsunami-affected areas in the North and East parts of the country. Funding will be channeled through a Trust Fund for which the World Bank has been asked to be the custodian and to which about $100 million has been pledged so far. Out of total tsunami pledges, staff estimates that Sri Lanka has now received $300–350 million in aid for reconstruction from official donors, NGOs/private sources, and the year-to-date impact of the debt moratorium. This is in addition to $158 million in emergency assistance from the IMF and about $65 million in humanitarian assistance by UN agencies.
Notwithstanding the political uncertainty, financial markets have remained stable. The exchange rate has hovered around Rs. 100/US$ since end-May and, despite some central bank intervention when the JVP quit the government, reserves remained at $2.1 billion (about 2.4 months of imports) as of July 6. Equity prices remain at about the same level as in May. The yields on the 3-month treasury bill have risen somewhat to about 9 percent, close to 200 basis points above their level at end-2004, as a result of the increases in policy rates and open market operations by the central bank.
GDP growth in the first quarter reached 4.8 percent (y/y), in line with expectations. The tsunami contributed to a slowdown in services, especially trade- and tourism-related, and had a devastating impact on fisheries, which contracted by 65 percent. Tourism, however, contracted by less than expected in the first quarter (arrivals decreased by 5 percent y/y) and arrivals in April-May were well above last year's levels. A good paddy harvest and a rebound in value added in the electricity sector (which was affected by a drought last year) helped offset the negative impact of the tsunami on GDP. The apparel sector also performed reasonably well and posted a growth rate of 7 percent.
Inflation moderated slightly in May, thanks to a decline in food prices, with the Sri Lanka CPI falling to about 13 percent (y/y). Although inflation measured by the Colombo CPI also fell in June, to below 10 percent, inflationary pressures remain a concern for the second half of the year, when reconstruction activity will pick up and adjustments in administered prices are expected to take place.
In accordance with the Fiscal Management (Responsibility) Act, the government presented to Parliament the Mid-Year Fiscal Position Report. In it, the overall fiscal deficit in the first four months of the year is estimated at about 3 percent of annual GDP. The latest revenue figures (20 percent growth y/y through May) are broadly in line with the staff revenue projections but high oil prices, which are currently above the assumptions used in the staff report, represent a risk to expenditure projections. Staff estimates that at current oil prices, additional subsidies of around ⅓ percent of GDP would be required unless fuel and diesel prices are adjusted by more than envisaged in the staff report.
On monetary policy, the CBSL appears to have been successful at moderating somewhat the pace of money creation. Thus, at end-June, reserve money growth stood at about 19 percent (y/y), compared to 21 percent at end-2004. Further tightening, however, will be necessary to rein in inflationary pressures. At its monthly meeting earlier this week, the Monetary Board left interest rates unchanged.
As regards the Ceylon Electricity Board (CEB), negotiations between the authorities and the unions have continued since the staff report was issued, but the main issues remain unresolved. The sticking point continues to be the unbundling of CEB, which the unions fear could facilitate privatization in the future. In the meantime, an increase in fixed charges for electricity has been announced.