The Central Bank of Sri Lanka today published “Recent Economic Developments: Highlights of 2021
and Prospects for 2022” online with an overview of the performance of the Sri Lankan economy in 2021, as reflected in “Recent Economic Developments”.
The Sri Lankan economy rebounded strongly from the COVID-19 pandemic induced contraction in The real economy grew by 8.0%, y-o-y, in the first half of 2021, registering a broad-based recovery of the major sectors of the economy. This recovery was underpinned by the extraordinary policy stimuli provided by the Government and the Central Bank across a wide spectrum of businesses and individuals, phasing out of the selective mobility restrictions in tandem with the
a nationwide vaccination programme, and normalising global activity.
The Government continued the fiscal stimulus measures announced in late 2019 by way of the low tax regime, among other direct financial support. The large scale debt moratoria provided to businesses and individuals were further extended during 2021, thereby smoothing the effects of cashflow disruptions faced by stakeholders amidst multiple waves of the pandemic. Due to the unprecedented monetary policy support provided by the Central Bank during 2020 and the maintenance of the same through January to mid August 2021, market interest rates declined to historically low levels, thereby facilitating credit to businesses and individuals, and supplementing investment needed to revive the economy.
The low interest rate environment benefitted fiscal operations amidst restricted access to global financial markets. Further, the Central Bank provided a large amount of funds to the Government by way of purchasing Treasury bills in bridging the widened financing gap in the midst of the pandemic. However, the Central Bank implemented monetary tightening measures in mid August 2021 by raising policy interest rates and the SRR (effective September 2021) in order to preempt the buildup of excessive inflationary pressures over the medium term, while also addressing imbalances in the external sector.
Merchandise exports reached pre-pandemic levels, while import expenditure also rose, reflecting the normalisation of activity as well as the escalation of prices of all key commodities in the global market. Amidst limited foreign exchange inflows under pandemic conditions, speculative activity exerted further pressure on the domestic foreign exchange market, warranting intervention by the Central Bank to impose a mandatory conversion requirement on export proceeds, provide exchange rate guidance, and ultimately provide liquidity support for essential imports. Meanwhile, the performance of trade in services remained dwarfed by the prolonged setback in the tourism industry, which is
expected to rebound fast as global travel activity resumes and vaccination against COVID-19 gathers pace. Workers’ remittances, which remained resilient amidst the pandemic, moderated in recent months, mainly reflecting the resumption of cross border travel, modest departures for foreign employment, and the search for exchange gains outside the banking system.
Heightened near term vulnerabilities in the external sector and pressures observed in the financial system owing to the moderation of foreign inflows are being addressed by the Government and the Central Bank through coordinated efforts. Concerted measures are being taken to promote foreign exchange earnings of the country, in terms of merchandise and services exports and workers’ remittances. The external current account balance is expected to improve over the medium term, supported by these efforts. FDI to large scale projects, and monetisation of non strategic assets, among others, are expected to attract sizeable non debt creating foreign inflows to the Government in the period ahead, thereby facilitating foreign currency debt servicing, along with several bridging finance facilities that are under discussion. Gross official reserves are expected to be enhanced to adequate levels in the period ahead, despite near term volatilities. The exchange rate continues to remain competitive as reflected by the real effective exchange rate indices.
The Government honoured all its foreign currency liabilities, in spite of speculation by various parties, including international sovereign rating agencies, about Sri Lanka’s ability to meet foreign debt service obligations. Meanwhile, the expansion of the Government budget deficit amidst the pandemic is expected to be curtailed along with the normalisation of activity and planned expenditure rationalisation measures by the Government over the medium term. Headline inflation, in the meantime, exceeded the upper bound of the target range of 4-6%, mainly due to continued high food prices, upward revisions to several administratively determined prices, and relaxation of price controls on selected imported commodities in tandem with the rising global commodity prices. Core inflation also recorded an uptick recently, indicating the strengthening of demand conditions of the economy. While headline inflation could remain above the targeted levels in the near term, the Central Bank remains committed to maintaining headline inflation at the target
range over the medium term under the flexible inflation targeting framework with appropriate preemptive measures as and when required, while ensuring the support needed for the economy to reach its potential growth trajectory.
Amidst measures to stabilise the economy from the effects of the pandemic, efforts of the government towards creating an export oriented production economy and diversifying economic activities with the support of domestic and foreign investors are expected to help sustain the growth momentum of the Sri Lankan economy over the medium term and enhance its resilience.