Sri Lanka Development Update November 2017 Creating opportunities - - PowerPoint PPT Presentation

Sri Lanka Development Update November 2017

www.worldbank.org/sldu

Creating opportunities and managing risks for sustained growth

Main takeaways

• 1. Macroeconomic performance continues to be broadly satisfactory, despite

significant challenges incl. natural disasters.

• 2. New Inland Revenue Act, increased VAT collection, relatively high inflation and

improved external reserves are key developments since the last update.

• 3. To increase and sustain growth, create jobs, and reduce poverty in the medium-

term, Sri Lanka needs to move towards a more private-investment and tradable sector driven model.

• 4. Continued fiscal consolidation, improved competitiveness, enhanced

accountability and governance are necessary ingredients.

• 5. Vision 2025 provides a strong platform for the new growth model.
• 6. To create new opportunities it is important to manage risks.

2 Sri Lanka Development Update – Creating Opportunities and Managing Risks for Sustained Growth - November 2017

Global environment continues to be benign

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• Global growth prospects have improved
• Commodity prices are still low though gradually increasing
• Global financial conditions are still benign
• GSP+ improves access to EU market

GDP growth 2015 2016 2017 2018 2019 Key financial flows to Sri Lanka Actual Estimates Projections World 2.7 2.4 2.7 2.9 2.9 United States 2.1 1.7 1.9 1.8 1.7 Textiles, Portfolio Flows United Kingdom 2.2 1.8 1.7 1.5 1.5 Textiles, Tourism, FDI Euro Area 2.0 1.8 1.7 1.5 1.5 Textiles, Tourism, Portfolio Flows China 6.9 6.7 6.5 6.3 6.3 Tourism, FDI, Official Financing India 8.6 7.1 7.0 7.3 7.4 Tourism, Remittances Saudi Arabia 4.1 1.4 0.6 2.0 2.1 Remittances Russia

• 2.8
• 0.2

1.3 1.4 1.4 Tea United Arab Emirates 3.8 2.3 2 2.5 3.2 Remittances Japan 1.1 1.0 1.5 1.0 0.6 Official Financing

Takeaway: best time to reform is now

Sri Lanka Development Update – Creating Opportunities and Managing Risks for Sustained Growth - November 2017 World Bank Global Economic Prospects, June 2017; South Asia Focus, October 2017; Global Economic Prospects Preliminary estimates http://www.worldbank.org/en/publication/global-economic-prospects

Growth has decelerated and is still largely driven by non- tradable sectors

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• Annual average growth decelerated from 7.3% (2009-12) to 4.4% (2013-16)
• Inward orientation is reflected in 70% of the total growth coming from 6 non-

tradable sectors Takeaway: need to change to more private investment-tradable sector growth model to sustain growth, jobs and poverty reduction

Rice Tea (Green leaves) Marine fishing Other agricultural Mining & quarrying F& B and tobacco Textiles & leather Construction Other industry Wholesale & retail trade Transportation & warehousing Accommodation, food & beverage services Financial services Real estate and

• wnership of dwelling

Professional services Education Health, residential care & social work Other personal services Other services

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2 4 6 8 10 12 14 16

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20 40 60 80 100 120 Contribution to growth 2010-2016 (percent) Growth 2010-2016

Sri Lanka Development Update – Creating Opportunities and Managing Risks for Sustained Growth - November 2017

Zooming in on the last 6 months, natural disasters continue to be a drag on macroeconomy

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• Construction (production side) and investment (expenditure side) drove growth,

while agriculture-related output fell due to floods and droughts.

• Inflation rose due to demand pressures, supply disruptions and one-off impact
• f VAT changes.
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2 4 6 8 10 12 14 1H 2011 1H 2012 1H 2013 1H 2014 1H 2015 1H 2016 1H 2017 Percent

Contributors to growth

Agriculture Construction Other industry Services Net taxes Overall growth

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1 2 3 4 5 6 7 8 Jan-16 Mar-16 May-16 Jul-16 Sep-16 Nov-16 Jan-17 Mar-17 May-17 Jul-17 Sep-17 Contributors to inflation Alcoholic beverages Others Restaurants & Hotels Communication Education Health Housing, Water & Energy Food

Takeaway: growth performance could have been better without the impact of natural disasters

Sri Lanka Development Update – Creating Opportunities and Managing Risks for Sustained Growth - November 2017

Natural disasters had widespread impact; poor were disproportionately affected

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Good news: poverty rate fell in 2016 from 2012/13 and rise in inequality stopped Floods and landslides in late May 2017

• Affected 15 of the 25 districts of Sri Lanka: significant loss of life (213) and property (LKR 70 billion)
• Total recovery needs are estimated at 1% of GDP

Drought in 2016 and 2017

• Affected 1,927,069 people across 17 districts
• Contraction of agriculture sector, food inflation: rice production for 2017 expected to be the lowest in

the last 10 years (sufficient only for 7 months)

• Need for more food and petroleum imports

Takeaway: Disaster risk management should be an integral part of the growth model

Sri Lanka Development Update – Creating Opportunities and Managing Risks for Sustained Growth - November 2017

Fiscal performance improved; however, significant risks remain

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• New Inland Revenue Act is the key highlight that could lead to structural increase in

revenues

• Primary fiscal surplus in 4 months of 2017 thanks to increased VAT revenue
• However, overall fiscal deficit probably higher than projected, as interest expenditure often

underestimated

• Public debt is high at 79% of GDP, but likely to stabilize; contingent liabilities are a

significant fiscal risk

(5.6) (5.4) (5.7) (7.6) (5.4)

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• 5
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• 3
• 2
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5 10 15 20 25 2012 2013 2014 2015 2016 Percent of GDP Percent of GDP Key fiscal aggregates Overall balance (RHS) Total revenue and grants Total expenditure 1 2 3 4 5 6 7 8 100 200 300 400 500 600 700 800 900 2011 2012 2013 2014 2015 2016 Percent LKR billion Treasury guaranteed debt CPC CEB RDA Others Share of GDP

Takeaway: fiscal & debt numbers moving in right direction, but important to manage quality of tax & spending, and composition/risks of debt & contingent liabilities

Sri Lanka Development Update – Creating Opportunities and Managing Risks for Sustained Growth - November 2017

Growth Negative real interest rates Exchange rate depreciation Primary fiscal deficits

Why is fiscal consolidation important to manage debt-to GDP? Before 2012

Decreasing debt-to-GDP Increasing debt-to-GDP

Growth Negative real interest rates Exchange rate depreciation Primary fiscal deficits Decreasing debt-to-GDP Increasing debt-to-GDP

Why is fiscal consolidation important to manage debt-to GDP? Before 2012

Growth Negative real interest rates Exchange rate depreciation Primary fiscal deficits Decreasing debt-to-GDP Increasing debt-to-GDP

Why is fiscal consolidation important to manage debt-to GDP? Before 2012

Growth Negative real interest rates Exchange rate depreciation Primary fiscal deficits Decreasing debt-to-GDP Increasing debt-to-GDP

Why is fiscal consolidation important to manage debt-to GDP? Before 2012

Growth Positive real interest rates Exchange rate depreciation Primary fiscal deficits

2013-16

Decreasing debt-to-GDP Increasing debt-to-GDP

Growth Positive real interest rates Exchange rate depreciation Primary fiscal deficits

2013-16

Decreasing debt-to-GDP Increasing debt-to-GDP

Growth Positive real interest rates Exchange rate depreciation Primary fiscal surpluses

2017-20

Decreasing debt-to-GDP Increasing debt-to-GDP

Growth Positive real interest rates Exchange rate depreciation Primary fiscal surpluses

2017-20

Decreasing debt-to-GDP Increasing debt-to-GDP

Title of Presentation 16

• 3.7%

2.6%

• 1.5%
• 10.0%
• 8.0%
• 6.0%
• 4.0%
• 2.0%

0.0% 2.0% 4.0% 6.0% 2003-12 2013-16 2017-20

Annual average change in debt-to-GDP ratio and the four forces

Real interest effect Growth effect Primary deficit effect Exchange rate effect Change in debt

Takeaway: With a more market-determined exchange rate and increasingly commercial terms on borrowing, sustained growth and fiscal consolidation is necessary to manage public debt-to-GDP ratio

External sector reported mixed messages

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• External trade balance weakened due to increased petroleum and food imports

while remittances shrank (Middle East) and tourism slowed down (airport closure and dengue).

• FDI more than doubled in the first half of 2017 due to inflows (Port City)
• Official reserves increased with forex purchases and external borrowings.
• External debt related risks remain high.

2.8 3.3 3.8 4.3 4.8 5.3 1,000 2,000 3,000 4,000 5,000 6,000 7,000 8,000 9,000 Feb-15 Apr-15 Jun-15 Aug-15 Oct-15 Dec-15 Feb-16 Apr-16 Jun-16 Aug-16 Oct-16 Dec-16 Feb-17 Apr-17 Jun-17 Aug-17 Months USD million

Official reserves

Reserves Official reserves to months of merchandise imports (RHS) 20 40 60 80 100 120 140 160 180 2 4 6 8 10 2010 2011 2012 2013 2014 2015 Percent Years

External debt indicators

Share of foreign currency commercial debt/official reserves (RHS) Average time to maturity

Takeaway: to strengthen external account, important to strengthen exports and FDI by implementing investment climate, trade and FDI reform agendas, use GSP+ as window of opportunity

Sri Lanka Development Update – Creating Opportunities and Managing Risks for Sustained Growth - November 2017

Monetary policy remained tight and financial sector remained stable

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• Banking sector’s capital adequacy, liquidity ratios, non-performing loans are

stable, but credit growth in certain sectors needs to be monitored

• High monetary growth showed signs of deceleration in response to tight policy

10 20 30 40 50 60 70 80 90 2011 2012 2013 2014 2015 2016 _Percent

Sector Credit as a share of Sector Value Addition

Agriculture Construction Textiles & Apparel Other industry Wholesale& retail Tourism Financial business

• 10
• 5

5 10 15 20 25 30 35 40 6 7 8 9 10 11 12 Jun-09 Dec-09 Jun-10 Dec-10 Jun-11 Dec-11 Jun-12 Dec-12 Jun-13 Dec-13 Jun-14 Dec-14 Jun-15 Dec-15 Jun-16 Dec-16 Jun-17 Percent, y-o-y Percent

Monetary policy and credit growth

Repo rate Reverse repo rate Growth in banking credit to Pvt sector (RHS)

Takeaway: monetary policy improved, but continued close monitoring of credit quality required

Sri Lanka Development Update – Creating Opportunities and Managing Risks for Sustained Growth - November 2017

Sri Lanka’s macro outlook continues to be steady

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• Expected to reach 4.6 percent in 2017 and grow marginally over 5.0 percent beyond,

driven by private consumption and investment.

Growth

• Will increase for the full year 2017 due to one-off impact of VAT and stabilize, low but

gradually increasing international commodity prices and base-effect will maintain downward pressure

Inflation

• Will narrow to 5.1% of GDP for 2017, although the budgeted fiscal target of 4.6% is

likely to be missed

• Revenue-led fiscal consolidation will continue with improving primary fiscal balances

Fiscal deficit

• Projected to stabilize at 79% of GDP and gradually fall, supported by primary fiscal

surplus and growth

Public debt

• Will benefit from tourism, and GSP+ in the second half of 2017 and 2018; however,

imports of food and petroleum will mask the improvement

• FDI and debt flows to close the financing gap

External sector

• Expected to improve with forex purchases, a more market-determined exchange rate,

monetary policy and divestment/lease out of some government assets

Reserves

Outlook remains steady, thanks to a strengthened global outlook, revenue-led fiscal consolidation program and pro-active monetary policy – reform implementation is necessary.

Sri Lanka Development Update – Creating Opportunities and Managing Risks for Sustained Growth - November 2017

Substantial downside risks could weigh on outlook

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Internal risks:

• Delay in

implementing revenue and debt management reforms

• Natural disasters
• Delays in structural

reforms in a complex political environment External risks:

• Disappointing growth performance in key countries
• Tightening global financial conditions
• Faster than expected rises in commodity prices

Sri Lanka Development Update – Creating Opportunities and Managing Risks for Sustained Growth - November 2017

Policy priorities

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• Implementation of new IR Act
• Improve tax administration
• VAT reforms
• Align spending to priorities

Stay on fiscal consolidation

• Trade policy & facilitation
• FDI attraction
• Innovation & business environment
• Institutional capacity and coordination
• Communication, trade adjustment

package

More private investment and export led model

• Implementation of Right to Information
• PFM reforms
• SOE reforms
• Audit function

Governance & Accountability Manage risks (Special focus section)

• Macroeconomy stability
• Debt sustainability
• Fiscal space for health,

education, social protection, disaster management and

• ther public investment
• Prepare for ageing
• A competitive economy
• Sustained growth towards

UMIC status

• More and better jobs
• Poverty reduction
• Public sector effectiveness
• Improved service delivery
• Improved citizens

engagement and public trust

Sri Lanka Development Update – Creating Opportunities and Managing Risks for Sustained Growth - November 2017

Vision 2025 envisions a new growth model: a knowledge-based, highly competitive, social market economy focused on inclusion

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• Become a rich

country by 2025 By 2020

• Per capita income
• f USD 5,000
• One million new

jobs

• FDI USD 5 billion

p.a.

• Exports USD 20

billion p.a.

Targets for 2020

• Less competitive,

Inward-oriented, non-tradable driven growth model

• Weak public

finances

• Strong anti-export

bias

• Weaknesses in

SOEs

• Low female labor

force participation

Key challenges

• Growth framework
• Macroeconomic

framework

• Factor market

reforms

• Governance and

accountability

• Social safety nets
• Sustainable

development

• Technology

Areas of focus

Sri Lanka Development Update – Creating Opportunities and Managing Risks for Sustained Growth - November 2017

23 Sri Lanka Development Update – Creating Opportunities and Managing Risks for Sustained Growth - November 2017

Special focus on creating opportunities and managing risks for sustained growth

Special focus on creating opportunities and managing risks for sustained growth

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• New growth model will create many opportunities to make Sri Lanka more resilient

to risks, but it will also expose them to new ones

• Risks need to be managed well to maximize opportunities
• Risks impact different levels of society: households, firms, public sector and the

macroeconomy

• An integrated approach to risk management is recommended (WDR, 2014) to

deal with risks.

• Potential key sources of risks include:
• Fiscal policy reforms (VAT and energy price reforms)
• Trade policy reforms
• Public debt and contingent liabilities
• Natural disasters

Sri Lanka Development Update – Creating Opportunities and Managing Risks for Sustained Growth - November 2017

• 1. Managing risks in fiscal reforms

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• VAT and energy price reforms to increase revenue and reduce fiscal risks

Reform

• Simpler and more predictable tax system for firms
• Increased fiscal space for education, health, other public investment; social

protection

• Macro stability with low inflation good for households, firms and the economy as a

whole

Opportunity

• Remove VAT exemptions (Often top-60% consumes 90%)
• Introduce cost-reflective fuel and energy pricing (Top-30% consumes 70% of fuel)

How

• Increased cost of living leading to vulnerable households falling into poverty
• Implications on firm competitiveness

Risk

• Couple the reform with targeted fiscal expenditure (cash transfers, focused public

investment, education and health); on VAT 25% needs to be transferred to compensate

• The better the targeting, the larger the net fiscal gain

Manage risks

Sri Lanka Development Update – Creating Opportunities and Managing Risks for Sustained Growth - November 2017

• 2. Managing risks in trade reforms

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• Further liberalization of trade: Low and declining export-to-GDP and concentration on

a few export products/markets could lead to slower growth and a less competitive economy creating fewer jobs

Reform

• More and better jobs in some sectors, more productive firms and new markets
• More export oriented FDI
• Increased tax revenue due to increased activity, in the medium-term
• Strengthened external position in the medium to long-term

Opportunity

• Phase out tariffs, rationalize duties
• Bilateral agreements
• Trade facilitation
• FDI attraction and retention

How

• Impact not uniform
• Shifts in relative prices of inputs and outputs faced by households and firms
• Revenue loss from reduced tariffs, offset by increasing revenue of remaining duties
• Weakened BoP in the short-run

Risk

• Strengthen social safety nets
• Improve business environment
• Implement trade adjustment programs

Manage risks

Sri Lanka Development Update – Creating Opportunities and Managing Risks for Sustained Growth - November 2017

• 3. Managing risks from public debt and contingent

liabilities

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• High public debt, deterioration of debt profile and increased cost and risk of debt,

fiscal risks from guaranteed and non-guaranteed SOE debt (12% of GDP estimated)

• Bunching of Eurobond repayments from 2019
• Structural challenges in debt management

Challenge

• Reduced cost or risk of debt portfolio
• Fiscal and macroeconomic stability
• Lower interest costs and improved access to finance for SMEs and households
• Domestic market development
• Reduced fiscal risks from SOEs

Opportunity

• Update legal framework and expedite unified debt management office
• Medium Term Debt Management Strategy to guide borrowing decisions and help

develop more liquid domestic debt market

• Active Liability Management to reduce refinancing risks
• Formulate a guarantee policy to manage contingent liabilities
• SOE reforms to improve performance and reduce fiscal risks

How

Sri Lanka Development Update – Creating Opportunities and Managing Risks for Sustained Growth - November 2017

• 4. Managing risks from natural disasters and impacts of

climate change

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• Increased frequency, severity and economic impact of natural disasters
• Disproportionate impact on poor households
• Slow response and lack of readily available data

Challenge

• Households less at risk from harm, loss of life, houses and jobs, food insecurity
• Fewer business interruptions
• Fewer fiscal shocks
• More stable macroeconomy

Opportunity

Better preparedness Physical resilience:

• Identify current and future climate and disaster risks
• Disaster and climate-resilient investment
• Improve disaster preparedness and physical response

Financial resilience:

• National disaster risk financing strategy
• Fast-disbursement mechanism of post-disaster operations
• National recovery plan for floods and landslides
• Catastrophic risk insurance for public assets

How

Sri Lanka Development Update – Creating Opportunities and Managing Risks for Sustained Growth - November 2017

Summarizing

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• There can be new opportunities for Sri Lanka,

if risks are managed well

• Risk management needs to happen at all

levels:

• Small shocks: households, firms and budget can cope
• If shock exceeds ability of households and firms to cope:

special role for government

• Sometimes even public sector and macroeconomy cannot

cope: role for international community and financial markets

• Strengthen capacity to analyze risks and

design and implement mitigation mechanisms; special role for budget

• Need to communicate better about the risks

and opportunities as well as pragmatic mitigation measures

Sri Lanka Development Update – Creating Opportunities and Managing Risks for Sustained Growth - November 2017

Takeaway:

• Anticipate
• Mitigate
• Communicate

Full report at: www.worldbank.org/sldu Previous editions:

• June 2017: Unleashing Sri Lanka’s trade potential
• October 2016: Structural challenges identified in the Systematic Country Diagnostic

Stay in touch with World Bank Sri Lanka! www.worldbank.lk @WorldBankSAsia @Idah_WB #SLDU2017 www.facebook.com/worldbanksrilanka instagram.com/worldbank/ www.linkedin.com/company/the-world-bank

30 Sri Lanka Development Update – Creating Opportunities and Managing Risks for Sustained Growth - November 2017