I. Our Targets
The President Mahinda Rajapakse as the Minister of Finance has once again reiterated in the Budget of 2012, the Government’s commitment to a sustainable growth target of 8% - 10%. A key objective of achieving this growth is to double per capita GDP to over $4,000 by 2016. The recent experiences of Vietnam and Malaysia provide important insights for developing a road map for achieving these goals.

The previous Economic Alert sought to highlight some of the threats to the investment climate generated by the Revival of Under-Performing Enterprises and Under -Utilized Assets Legislation.

It concluded that such legislation was potentially damaging at a time when the country needs private investment (both domestic and foreign) to increase by at least 6% - 7% of GDP (USD 3-3.5 billion) in order to meet the government’s minimum growth target of 8%. It was argued that the legislation had the potential to undermine both domestic and foreign investment. At a time when domestic investors need to increase their risk appetites and extend their pay-off periods, following the end of the conflict, it is important to pursue policies that encourage them to do so. In addition, any legislation that has even the slightest sense of expropriation is likely to concern potential foreign investors who have numerous destinations to choose from both in the region and elsewhere.

Investment needs to increase from 28% (2010) to 34% of GDP to attain the government’s growth target of 8%, as Sri Lanka’s incremental capital output ratio is 4.2. Public investment has been capped at 6% - 7% of GDP. This means that private investment, both domestic and foreign, needs to increase from the current 21% of GDP to 27-28%. It is, therefore, important to create a conducive business climate that encourages private investors to fill this gap. Failure to do so will mean that the government’s growth target will not be met on a sustained basis. Attempts to circumvent the lack of private investment by raising the level of public investment are likely to undermine the government’s own fiscal consolidation targets and thereby have an adverse impact on the country’s macroeconomic fundamentals. As a lower-middle-income country with an increasing exposure to capital markets, Sri Lanka cannot afford to allow this to happen.

Sri Lanka is now a lower-middle-income country. Moving out of low-income country status and a reliance on handouts is certainly a source of pride for all Sri Lankans. However, this newly won status also places greater responsibilities on the shoulders of the policy-makers, particularly in the Central Bank of Sri Lanka (CBSL) and the Ministry of Finance. With lower-middle-income country status, a nation loses access to concessional resources (aid) and experiences greater exposure to the discipline exerted by commercial markets. This places a very high premium on prudent macroeconomic management based on timely action. The costs of policy mistakes have become dramatically higher.

Introduction
Growth has stalled in the global economy. Stock markets have plummeted. Risk appetite has declined and there has been a flow of resources to safe havens. The IMF has stated that the world economy has entered its most dangerous phase since the financial crisis of 2008. The ammunition available to policy-makers is much reduced with interest rates at extremely low levels and the scope for expansionary fiscal policy circumscribed by the large stimulus packages already introduced.

The issue of state-owned land being offered to foreign and local investors on freehold or long-term leases , for establishing commercial projects, has been the subject of much debate both in Parliament and the media. The public debate is focused mostly on prime land in Colombo city. However, the arguments for and against the sale of state land also apply to transactions in other parts of the country. One extreme argument is that none of the government owned-land should be divested to any local or foreign investors but allowed to remain with the state, whether productively used, under-utilised or completely unused. The opposite of this argument is that the state should not own any land other than for security, environmental or other such reasons, while allowing any enterprise to utilize other land for producing goods and services thereby generating employment and increasing incomes.

Since nationalization of the petroleum import and distribution trade in 1961 successive Sri Lankan Governments have continued to carry the burden of operating this business. During the past four decades, the political and economic burden became evident with the drastic increase of prices, partly due to the cartel exercised by OPEC. This has meant that price increases as well as product and service quality have been key issues for Opposition political parties in leveling criticism against any government that was in power. In the recent past too, we have seen the Government being criticized on petroleum trade related issues.

There was a significant policy shift, in 2005, when the government took the decision not to privatize any State Owned Enterprises (SOEs). Instead, priority was attached to improving their operations. In order to achieve this objective, all SOEs have been called upon to revisit their vision, strategies and business models in line with national objectives. The government invested Rs. 635 billion in SOE’s during 2005 – 09. The return on investment to the government is generated through levies and dividends declared on SOE profits after tax. These rose from Rs. 5.9 billion in 2005 to Rs. 23.7 billion in 2009. The most significant contributors were the state-owned banks, the Telecommunications Regulatory Commission and the National Insurance Trust Fund. There has also been a turnaround in the performance of the non-functioning SOEs. This has enabled the government to reduce its subventions (recurrent and capital) to these enterprises from Rs. 2.8 billion in 2006 to Rs. 486 million in 2009.

Over the last 50 years, the civil conflict, a dramatic decline in terms of trade, demographic pressures and misguided policies were major contributory factors to Sri Lanka’s economic underperformance. The current prospects are significantly more propitious not only because of the absence of major ‘drags’ on the economy but also due to favourable economic geography (previous Economic Alerts have elaborated on this). The government has set a growth target of 8% in the medium term. It also aims to double per capita GDP to over $4,000 by 2016. This would require average annual real growth rates in double digits.

The debate regarding private participation in the provision of tertiary education, in Sri Lanka, has been around for a long time. Attempts to establish private universities have met with fierce resistance in the past. For instance, the North Colombo Private Medical College was taken over by the government due to strong pressure from various vested interests.

Recent press reports have indicated that all the ASEAN member countries have now ratified a Comprehensive Economic Partnership Agreement (CEPA) with India. This agreement is expected to come into effect by the end of 2011. Sri Lanka had a head start when the Indo – Sri Lanka Free Trade Agreement (ISLFTA) was implemented in 2000 and negotiations were commenced on an Indo – Lanka CEPA in 2003. The news of all ASEAN countries ratifying their CEPA with India, at a time when the Indo – Lanka agreement has stalled, raises the question whether Sri Lanka is about to miss a second transformative opportunity in a generation.

Recent political developments in North Africa and the Middle East, and the destructive earthquake and Tsunami in Japan, have created major uncertainties related to oil prices and international trade, resulting in elevated risks for all countries. The impacts of these phenomena are global in reach and will, therefore, have ramifications for the Sri Lankan economy. There are several channels through which the effects are likely to be transmitted: oil prices; tea and rubber prices; remittances; capital flows; changes in the value of the Yen; and businesses dependent on Japanese imports. At the macro level, prices (inflation), the balance of payments and possibly the budget are likely to be affected.