Despite its status as a frontier market, Sri Lanka will not escape the global downturn unscathed, andwe envisage difficult economic challenges in 2009. Growth will come in far below trend, the currentaccount and fiscal deficits will continue to widen, and the level of public debt will remain elevated.While we foresee an improvement in the political situation pending a victory of the armed forcesover the rebel Liberation Tigers of Tamil Eelam (LTTE, Tamil Tigers), achieving a durable peacewill be a formidable task. That said, we expect the economy to rebound strongly from 2011 as agradual stabilisation of the security situation feeds into higher levels of tourism and investment.
While our long-term outlook for the Sri Lankan economy remains broadly positive, the ongoingdeterioration of global economic conditions has led us to revise our growth forecasts for 2009 and2010 downward. The impact of the global crisis has already been felt through weaker exports,foreign direct investment and remittances, which we expect to have a negative impact on privateconsumption growth. Although government spending will provide a modest boost to the economy,the precarious state of public finances will limit the scale of such expenditures. Nevertheless, weforesee growth coming at 2.2% in 2009, and picking up thereafter to reach 4.3% in 2010.
On the political front, 2009 will see a tentative return to stability with the campaign against theTamil Tigers expected to wrap up in the first half of the year. However, we caution that the rebels’fundamental objectives are unchanged, and that they could continue to plan terrorist attacks. Furthermore,the government will come under increasing international pressure to broker a politicalresolution that addresses the grievances of the Tamil minority. Nonetheless, it will need to balancethis pressure against the demands of the Sinhalese nationalist majority on which it will rely to gainre-election in 2010, or even 2009 if elections are brought forward.
Despite the government’s progress in subduing the rebels, which should ease security concerns,the underlying issues affecting Sri Lanka’s business environment are mostly unchanged. Theseproblems include corruption in the judiciary (and particularly in the contract-bidding process) aswell as inadequate physical infrastructure. Although the government is pressing ahead with itsinfrastructure programme, it relies on increasingly scarce foreign funding to do so. More broadly,the business environment is unlikely to see a significant improvement under President MahindaRajapaksa, who has been pursuing a more protectionist and less business-friendly economic policythan his predecessor.
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