Sri Lanka’s large current account deficit, high foreign debt, and openness to capital flows suggest that it remains especially vulnerable to tightening of international financial conditions: World Bank

Economic downturn       South Asia’s GDP growth rose to an estimated 4.6 percent in 2013 from 4.2 percent in 2012 on a market price-calendar year basis. Growth was, however, well below its pre-crisis pace, reflecting a combination of domestic imbalances, weakening investment rates, and a challenging external environment.

A cyclical recovery in the second half of 2013 was led by a rapid expansion of regional exports, reflecting a gradual recovery in global demand and currency depreciation in India. India was hit particularly hard by a withdrawal of portfolio capital (resulting in steep depreciation of the rupee) in mid-year, stemming from apprehensions of tapering of U.S. quantitative easing. Although retail inflation remained high in some countries, normal harvests and lower international commodity prices helped stabilize consumption growth in South Asia.

Sri Lanka experienced a significant decline in inflation during the course of 2013. In India, however, despite a negative output gap, consumer price inflation remained elevated at close to 10 percent (y/y) for much of the year. Pakistan also  faced inflationary pressures, while inflation picked up towards end of the year in Bangladesh.

The growth  of remittances to South Asia moderated to an estimated 6.8 percent in 2013 from 9.7 percent in 2012. While India was the largest recipient by size, relative to GDP remittances were more important resource flows for Bangladesh, Nepal, Pakistan, and Sri Lanka in 2013.

Despite high economic growth and low inflation, Sri Lanka remains vulnerable to tightening of international financial conditions due to its high external debt, the World Bank’s latest Global Economic Prospects (GEP) report,  says.

The external debt as a share of GDP is modest in most South Asian countries, but in Sri Lanka, it is close to 80% of GDP, according to the GEP report.

Sri Lanka’s large current account deficit, high foreign debt, and openness to capital flows suggest that it remains especially vulnerable to tightening of international financial conditions, the report cautions.

Sri Lanka experienced a growth of an estimated 7.0% in 2013 rising from 6.4% in 2012, with stronger manufacturing and services activity and a rebound in agriculture in the third quarter of 2013.

Sri Lanka’s growth is projected to accelerate to 7.4% in 2014, mainly as a result of infrastructure spending, and consumption and services activity maintained by remittance inflows.

Over the medium term, however, Sri Lanka’s growth is projected to slow to a more sustainable rate. The GEP report projects a growth rate of 6.5% for 2015 and 6.3% for 2016.

However, for South Asia regional GDP growth is projected to improve to 5.7% in 2014 in market price terms, and to rise to 6.3% in 2015 and 6.7% in 2016.

Lower international commodity prices helped ease inflation in Sri Lanka which experienced a significant decline in inflation momentum during the course of 2013.

Remittance flows to Sri Lanka experienced double-digit growth of 10% of GDP in the 2013 calendar year. Sri Lanka’s deficit has fallen in recent years, but is estimated to be nearly 6% of GDP in 2013.The current account balance as a percentage share of nominal GDP is expected to decline to a projected -3.2% in 2016 from -4.4 forecast for 2014.

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