TL 1070

Economies’ Potential to Achieve Higher Growth Targets

Name: Thushan Dharmawardana

Index no : 101414G

Submission date: 17/10/2011

Contents

Introduction page 1

Current Macroeconomic Situation page 2

Strengths and Weaknesses highlighted by economic indicators page 2

Feasibility of 9 % growth rate page 5

Areas of Policy Focus page 7

Negative Implications of pursuing higher growth rate page 9

Introduction

After the free trade agreement in 1975 Sri Lankan economy has faced with certain circumstances that affected negatively on the growth of the economy as a whole. Now Sri Lankan Economy is in a situation where it is potentially growing in leaps and bounces after the liberation from terrorism. Considering the latest Central Bank Report Sri Lanka is having a prospective growth in all the 3 main sectors in Gross Domestic Product.

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Current Macroeconomic Situation

2006 2007 2008 2009 20100

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AgricultureIndustry Services

Year

Rs. B

illio

ns

Figure 1

Data Source: Central Bank Report

Considering the above chart the Gross Domestic Product of Sri Lankan Economy has increased over the last five years. The increment rate of GDP for the last year has increased significantly over the last year. Sri Lanka is in an advantageous situation considering basic macroeconomic indicators like inflation, unemployment and per capita income. According to the central bank sources inflation and unemployment rate has now turned out to be a one figure value. It took Sri Lanka 55 years to reach a per capita income of US$ 1,000 and during the last four years it has been doubled, which indicates a clear progress in Sri Lankan Economy.

Adding to those aspects New York Times had said that Sri Lanka is the best place to visit in 2010, Wall street Journal had said that Sri Lanka will be one of the top ten countries for growth in the coming years. These recommendations and predictions show how economically prospective Sri Lanka is considering the macro picture.  

Strengths and Weaknesses highlighted by economic indicators

Pursuing towards a higher growth rate Sri Lanka has some factors which thrusts and drags which evolves in making up the final growth rate.

Sri Lanka is an important fragment of the world economy because of its geographical situation therefore it is considered as a transport hub. The constituted open economy remaining in the

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country also provides ample opportunities for the agricultural, industrial and services sectors to grow. Sri Lanka has the second highest literacy rate in South Asia which makes Sri Lanka competent among the other economies. Nowadays English is widely used in urban an area that’s also a good sign towards a better Sri Lanka. According to Central bank sources Sri Lanka tourism is also booming after the eradication of terrorism.

Year Tourist arrivals

2005 549,308

2006 559,603

2007 494,008

2008 438,475

2009 447,890

2010 654,476

Data Source: Sri Lanka Socio Economic Data – Central Bank of Sri Lanka

In year 2010 tourism sector in Sri Lanka achieved a growth rate of 46.12 % which demonstrate the opportunities Sri Lankan citizens would have to involve in economic growth. Sri Lanka also has a booming and modern services sector. As shown in figure 1 the services sector has become more efficient. Tourism, banking, finance, and retail trade are the major components of the service sector. Also IT industry has made some rapid progress over the past few years, becoming a fountain of jobs for Sri Lankan youth.

Apart from the above mentioned aspects there are some negative attributes attached to Sri Lankan Economy. Human capital is the most important resource for a nation to advance towards a better position in world economy. Unfortunately ‘brain drain’ is a severe issue which undermines human capital base.

Loss incurring state owned enterprises, low public investment and high fiscal deficits decelerates the growth rates of economy.

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2006 2007 2008 2009 20100

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Budget DeficitPublic Debt

Year

% o

f GDP

Data Source: Central Bank Report

Figure 2

As shown in the above figure the budget deficit of the country is rotating around a same percentage of GDP but there doesn’t seems an end of this cumulative debt public have to pay one way or another. There is also a high regional inequality considering the growth of gross domestic product. Mostly urban areas are obtaining the benefit of economic growth while other areas don’t have the opportunity to acquire above mentioned efficient and quality services. To flourish as a nation all regions should contribute with its fullest potential. Infrastructure deficits in an economy such as roads, electricity makes the situation worse.

year Road Kilometers New registration of motor vehicles

2005 11661 2296692006 11773 3005222007 11902 2978922008 11902 2651992009 11919 2040752010 11923 359243

Data Source: Sri Lanka Socio Economic Data – Central Bank of Sri Lanka

The rate of new vehicles approaching roads has increased immensely while the transportation infrastructure remains the same. Addition of motor vehicles assists congestion on roads that wastes resources that could have been utilized for economic development.

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Feasibility of 9 % growth rate

To achieve the above mentioned target Sri Lankan economy has to overcome certain challenges. The employment levels should increase while getting rid of the budget deficit. Higher productivity should be attained and investment should increase to obtain a growth rate of 9%

ICOR * g = 1/Y

ICOR – Incremental capital output ratio

g – Growth rate

Y – Current GDP

ICOR value determines how much output a given amount of investment will bring. Considering the above formula to increase the growth rate of a country ICOR value should decrease. Normally in Sri Lanka ICOR value is about 5 while in USA is about 2.5.

Figure 3

Source: John Diandas Memorial Oration

A real growth rate of over 9% during the next five years will mean the Sri Lanka economy should have a GDP around USD 120 Billion at current market prices and a per capita GDP around 4800. At the moment Sri Lanka is having an ICOR value of 4.5 therefore for a 9 % growth rate there should be an increase of about 40 % of GDP. If investors involve in more to the economy and with a lower ICOR value, increasing the capital stock productivity it is certainly feasible to achieve a growth rate of 9 %. Sri Lanka should focus on commercial agriculture and a dynamic services sector. Improving productivity in main sectors of an economy is the key to accelerate economic growth.

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Achieving a higher growth rate also derived by the educational level in a country but recently the government expenditure on education has reduced significantly. It should be revised and more and more investment on education should be done to have a sustainable long term economic growth.

2006-07 2007-08 2008-09 2009-10

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GDP increase

GDP increase

period

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aes i

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P

Figure 4

Data Source: Central Bank Report

As shown in the above figure 23 % GDP increase has been achieved in 2007/2008 period in spite of the civil war. Therefore with lots of business ventures coming up Sri Lankan economy can surely have that 40% GDP increase needed in order to gain 9% growth rate.

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Areas of policy focus

There are some policies that can be implemented in achieving the growth targets. Even though there are some negative aspects, privatization in my opinion is a good option. Through privatization productivity and efficiency will be increased and therefore productivity of capital stock would increase and simultaneously ICOR value would also decrease.

Government should consider on fiscal policy and taxation paying special attention to the declining trend of government revenue. The monetary policy also should be simple to understand making it feasible to short and medium term management of the economy. In other words interest rates and tax rates should be manipulated transparently.

2006 2007 2008 2009 20100

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government revenueTotal government expendi-tureOutstanding Government Debt

Year

Rs.m

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Figure 5

Data Source: Central Bank Report

As shown in the figure outstanding government debt is increasing in a rapid rate therefore government can’t take the risk of moving with Keynesian policy. Government should try to increase their revenue while cutting down their expenditure through effective utilization of above policies.

PPI (Producer Price Index) and CPI (Consumer Price Index) are also important factors considering the economy. These two aspects measure the inflation rate of a country. Inflation plays a key role in the economic growth that a small inflation rate can cause a larger reduction of per capita income. Inflation also reduces the level of business investment and the efficiency with

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which productive factors are put to use. Therefore managing these indices are important in achieving the growth targets.

2006 2007 2008 2009 20100

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inflationgrowth rate

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enta

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Figure 6

Usually inflation and growth rate have a negative relationship but in year 2009 as shown in the graph drastic decrease in inflation has occurred. The method of calculating inflation in year 2009 is suspicious because calculation did not include some consumer goods. Nevertheless having a lesser inflation rate is better considering the growth of an economy. Economic infrastructure investment raises productivity and lowers production costs. Investing in physical infrastructure enhances the private sector efficiency and growth.

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Negative Implications of pursuing higher growth rate

Rapid rate of growth might be at the expense of the current account of the balance of payments. When economy grows up the aggregate demand for goods also increases. In the normal scenario when more money hangs around people there occurs a propensity on imports more than exports. Therefore larger economic growth might construct larger trade deficits. However economic growth can be achieved without worsening the balance of payment in goods and services. The exchange rate should be strong, therefore relative prices of goods coming to Sri Lankan economy falls. Vice Versa price of export goods will rise. This will lead to a favourable balance of trade and a higher growth rate.

GDP of a country might rise but the benefits of the growth are not evenly distributed. This will lead to income and wealth inequality where it creates an enormous contradiction between the richest and the poorest elements of the population.

At the same time there is a possibility of demand pull and cost push inflation in the long run if demand grows faster than anticipated .Higher inflation can lead to rise in interest rates and can cause a loss of competitiveness for local producers in the international market.

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Population ( thousands )GDP ( Rs. Billions)

Figure 7

Considering the above graph highest GDP/Population ratio is from Western province which indicates the inequality of sharing benefits of the booming economy.

Fast growth of production and consumption can create negative externalities such as increased noise and air pollution and road congestion. Environmental damage can have a negative effect on our quality of life and limits our sustainable rate of growth. Therefore focus should be on a

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sustainable economic growth. To achieve this sustainable economic growth government should follow a policy such as ‘Green Growth’ concept implemented in other Asia Pacific Countries.

Therefore we have to consider on all those factors and have a strategic plan where the negative implications can be mitigated and achieve the expected growth target.

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