World Bank upbeat on SL but says challenges equally high

The World Bank last week reiterated its confidence on Sri Lanka but at the same emphasized challenges are equally high for the country to achieve the desired success in a post-war era midst global crisis.
In a report titled “Sri Lanka Economic Update” the Bank also said that if the country were to achieve 2009 fiscal targets, a doubling of effort is needed to shore up sagging revenue and check rapidly rising current expenditure. *End of conflict provides
historic opportunity
to achieve transformation
*Address minorities’
underlying grievances
*Significant structural
policy agenda needed
*Doubling of efforts needed to boost revenue
“The end of armed conflict provides Sri Lanka with a historic opportunity to achieve a dual transition from a low income country in conflict to a middle income country in peace,” the report said adding that for longer-term stability needed to bolster the investment climate it would be necessary to address minorities’ underlying grievances.
The report said preliminary estimates suggest that Sri Lanka’s long-term potential growth rate is around 6 percent. “The post-conflict boom may help Sri Lanka to return relatively rapidly to growth rates in this range, but is unlikely to significantly increase the longterm potential growth rate, unless a significant structural policy agenda is implemented,” the World Bank report added.
It also said that in the short-to-medium term, prospects for the Sri Lankan economy look positive. First, there are increasing signs that the global economic crisis is bottoming out. Prospects of a global recovery would provide enhanced growth impetus through recovery in exports, increase in tourism and possible greater FDI inflow.
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).
From a simple growth accounting perspective, the report also said 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.
Better debt management was also stressed along with fiscal prudence. Noting that Government’s commitment under the IMF program is to see the fiscal deficit contained to 7 percent of GDP in 2009, the report said 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 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. An important motivation for the fiscal consolidation effort has been concern over debt sustainability, the World Bank report added.