Perspectives for accelerated growth and development:

Economy on track

Presidential address by Professor A D V de S Indraratna at the Sri Lanka Economic Association 2010 Annual Sessions

The theme of this year’s annual sessions is ‘Perspectives for accelerated growth and development.’ Why both growth and development? Are they not the same? Or are they very different? Neither is the answer. By growth I mean economic growth in the sense of increase in the GDP as measured by the increase in the total net output of goods and services over a period of time, whereas development is increase in welfare or improvement in quality of life of a people or nation over a period.

Development is of wider connotation than economic growth and includes not only material or physical welfare as judged by the increase in the available goods and services but also the level of education, health, environment, security etc.

For development, economic growth as defined here is vital, but is not sufficient; it must be inclusive growth, l am mentioning this because often we tend to use them alternately, implicitly giving the impression that they are the same and not different.

Global recession

Be that as it may, this year’s theme of perspectives for accelerated growth and development is more or less a continuation of the dialogue SLEA started a year ago with ‘The way forward to recovery from the fall-out of the global recession’, the theme of last year’s annual sessions.

This year’s theme is of great relevance as a follow-up of last year’s. In my Presidential address, at the inauguration of the sessions last year, I mentioned, that the adverse impact of the recession on the world economy was more severe than any other recession since the Great Depression of the early thirties and the countries which had direct links with the US and European banking and financial institutions and heavily depended on the West for trade and investment, were very badly hit. However, the direct impact of the immediately ensuing global financial crisis of this recession on Sri Lanka’s financial sector was relatively very little. I further added, that Sri Lanka, however, was adversely affected with the onset of its second round fall-out on the real sector, in and after the fourth quarter of 2008.

For instance, despite the intensification of the terrorist war, the Sri Lankan economy had performed well in the preceding four years of 2005-2008 with an average growth rate of more than 6.5 percent with unemployment declining to 5.4 percent of the labour force by the end of the period. Exports had grown continuously with the volume of exports standing nearly 20 percent above that of 2004.

The BOP (Balance of Payments) surplus had peaked to US$ 515 million by July 2008 and gross official reserves had increased to US$ 3.5 billion, nearly four months of import value. This trend, however, reversed in the fourth quarter of 2008 with the onset of the second round effects of the global recession. There was withdrawal of investment in Treasury Bills and Bonds by foreign investors; there was drying up of commercial financing from international capital markets required for counterpart funds for foreign funded projects. Export growth had begun to decline ending in a drop of about 10 percent by May 2009 over that of 2008.

Growth rate

Despite the steady and in fact slightly increasing, private remittances - private remittances in the first half of this year was 5 percent higher than in the corresponding period last year- the BOP began to be in deficit and gross official reserves had begun to decline recording the lowest of US$1.2 billion by March 2009, hardly adequate for two months of imports.

Overall, the growth rate, which was more than 6.5 percent from 2005 up to the third quarter of 2008, had declined to 4.3 percent in the fourth quarter of 2008 and still further down to 1.5 percent in the first quarter of 2009.

With the launching of prudent monetary policies by the Central Bank and the end of the terrorist war in May 2009, Sri Lanka was able to reverse the downward economic swing. The economy once again picked up with the growth rate rising to 2.1 percent in the second quarter and accelerating in the third and fourth quarters, ended the year with an annual average of 3.5 percent.

This growth rate more than doubled with seven percent and 8.5 percent (on a point to point basis) in the first and second quarters of this year respectively. Unemployment was coming down and gross official reserves reached an unprecedented level of US$ six billion in the third quarter, sufficient to meet the cost of imports of nearly seven months at current prices.

Terrorist hostilities

It is noteworthy that the Government was able to attain this fast and significant recovery and to sustain over 6 percent growth for three consecutive quarters, with single digit inflation of around 6 percent. This was possible because the Government, while meeting the challenges of the aftermath of the cessation of terrorist hostilities, has been utilizing the opportunities opened by it.

For example, the Government has been utilizing the opportunity of liberation of one third of the country’s territory and two thirds of its sea coast, for restoration and further development, of agriculture, fisheries and tourism. The contribution made by both agriculture and fisheries to the country’s GDP has been rising considerably since mid 2009, while tourism has made significant gains, with tourist arrivals increasing by nearly 50 percent, with tourist earnings even more than 60 percent, in the first nine months of this year over the corresponding period last year.

The Government has also been utilizing the vast pool of skilled manpower with the release of the Armed Forces from the battlefield. They are now being increasingly used for delivering essential services such as rebuilding habitats and restoring vital physical infrastructure to whole tracts of land decimated by terrorism.

Future prospect

In this scenario, can the country, as indicated in the Mahinda Chintana - Idiri Dekma, sustain a high average annual growth of around eight percent in the next five years (2011-2015) or so, and able to reduce unemployment to a tolerable level of 3 percent (so called natural rate of unemployment-NRU) and halve poverty to meet the MDG? This is a crucial question that is being raised in economists’ parlance!

The growth of an economy must be measured in real terms, i.e., by the growth of the GDP in real terms or at constant prices. This depends upon the level or rate of investment as a percentage of GDP and the efficiency of that investment (or in economic jargon capital output ratio).

The rate or level of gross investment required to attain a target, or given rate of growth thus depends upon the efficiency of capital. The higher this level of efficiency, the lower the rate of investment required.

Developed countries

The level of efficiency of our investment or productivity of our capital has been very low in comparison with productivity not only of developed countries but also in comparison with that of even developing countries of Asia. In the last five completed years, the average ratio has been 4.2:1, i.e in order to produce I unit of output, 4.2 units of investment or capital have been utilized.

On this basis, for a real growth rate of 8 percent of GDP, a gross investment rate of nearly 34 percent of GDP is required. In the past five years the gross rate of investment has been only 27 percent of GDP. The rate of domestic savings available to meet even this level of investment has been as low as 17 percent. This investment-savings gap (or the resource gap) had to be met by mainly domestic and foreign borrowing. For the flow of FDI has been rather slow.

When the required level of GDP goes up to 34 percent, the gap increases by 70 percent, at the present level of savings, and this gap becomes more difficult to fill. This makes an 8 percent or more growth rate appear unsustainable. But we should not be pessimistic. Prospects are not that bad and all indications are that, if a multi pronged attack is made, the gap could be reduced if not all together eliminated.

It has to be multi pronged, because the gap should be resolved firstly by increasing the level of efficiency of investment, thereby reducing the percentage of GDP required to be invested for the targeted rate of growth (that is reducing the capital or investment output ratio) secondly it has to be done by raising the present percentage of domestic savings and thirdly by increasing FDI in order to augment the domestic investment.

Level of investment

Except for the last, i.e., FDI, the ominous signs for the other two appear bright as judged by the experience of growth in the last quarter of 2009 and the first two quarters of 2010. The growth rate has been rising steadily from about 6.2 percent in the last quarter of 2009 to 8.5 percent in the second quarter of 2010 without a significant increase in the rate of gross investment (as per the data available at present).

This means that there has been some improvement in the level of efficiency of investment. If we can increase the present level of efficiency of capital by about 10 percent to around 3.75:1, then we should be able to attain the targeted growth rate of 8 percent with a gross investment of only 30 percent, a 10 percent increase over the present level.

To be continued