Overview of Sri Lankan Economy Sri Lanka is a lower-middle income developing nation with a gross domestic product of about

$41 billion. This translates into a per capita income of $2,000. Sri Lanka's 91% literacy rate in local languages and life expectancy of 72 years rank well above those of India, Bangladesh, and Pakistan. English language ability is relatively high but has declined significantly since the 1970s. Sri Lanka's income inequality is severe, with striking differences between rural and urban areas. About 15% of the country's population of 20.2 million remains impoverished. The effects of 26 years of civil conflict, falling agricultural labor productivity, lack of income-earning opportunities for the rural population, high inflation, and poor infrastructure outside the Western Province are impediments to poverty reduction. In 1978, Sri Lanka shifted away from a socialist orientation and opened its economy to foreign investment. But the pace of reform has been uneven. A period of aggressive economic reform under the UNP-led government that ruled from 2002 to 2004 was followed by a more statist approach under former President Chandrika Kumaratunga and current President Mahinda Rajapaksa. Despite a brutal civil war that began in 1983, economic growth has averaged around 4.5%. In 2001, however, GDP growth was negative 1.4%--the only contraction since independence. Growth recovered to 4.0% in 2002. Following the 2002 ceasefire and subsequent economic reforms, the economy grew more rapidly, recording growth rates of 6.0% in 2003 and 5.4% in 2004. The December 2004 Indian Ocean tsunami killed 32,000 people, displaced 443,000, and caused an estimated $1 billion in damage. The tsunami's overall economic impact was less severe than originally feared, with the economy growing by 6% in 2005 and 7.7% in 2006 as the damage was offset by the reconstruction effort. The economic situation in Sri Lanka is stable, but has been hampered by hostilities between the government and the LTTE, high government expenditure, and high inflation and interest rates. GDP grew by 6% in 2008, down from 6.8% growth in 2007. Exports were up 6.5%. Garments, the top export, were up 4%. Remittances from Sri Lankan citizens working abroad remained

strong in 2008. Nevertheless, both the trade and current accounts recorded large deficits due to high oil and commodity prices. Furthermore, an unsuccessful effort by the government to defend the Sri Lankan rupee drained Sri Lankas exchange reserves, forcing it to turn to the International Monetary Fund (IMF) in early 2009 for assistance. In early 2009, the effects of the global economic crisis were evident, with both exports and remittances on the decline. President Rajapaksa's broad economic strategy was outlined in his election manifesto "Mahinda Chintana" (Mahinda's Thoughts), which now guides government economic policy. Mahinda Chintana policies focus on poverty alleviation and steering investment to disadvantaged areas; developing the small and medium enterprise (SME) sector; promotion of agriculture; and expanding the already enormous civil service. The Rajapaksa Government rejects the privatization of state enterprises, including "strategic" enterprises such as state-owned banks, airports, and electrical utilities. Instead, it plans to retain ownership and management of these enterprises and make them profitable. The future of Sri Lanka's economic health primarily depends on political stability, return to peace, and continued policy reforms--particularly in the area of fiscal discipline and budget management. Rising oil costs and the 24-year conflict have contributed to Sri Lanka's high public debt load (86% of GDP in 2007). Sri Lanka needs economic growth rates of 7-8% and investment levels of about 30% of GDP for a sustainable reduction in unemployment and poverty. In the past 10 years, investment levels have averaged around 25% of GDP. Sri Lanka depends on a continued strong global economy for investment and for expansion of its export base. The government plans an ambitious infrastructure development program to boost growth. It hopes to diversify export products and destinations to make use of the Indo-Lanka and Pakistan-Sri Lanka Free Trade Agreements, GSP+ treatment by the European Union and other regional and bilateral preferential trading agreements. The service sector is the largest component of GDP at around 60%. In 2008, the service sector growth slowed to 5.6% from over 7% in 2006-2007. Telecom, trading, transport, and financial services were the main contributors to growth. Public administration and defense expenditures increased in recent years due to hostilities, expansion of public sector employment, and the

expenses associated with maintaining a 106-minister cabinet. There also is a growing information technology sector, especially information technology training and software development. The tourism sector has been impeded by the volatile security situation.

Industry accounts for 28% of GDP. Manufacturing is the largest industrial subsector, accounting for 18% of GDP. The construction sector accounts for 7% of GDP. Mining and quarrying account for 1.5% of GDP. Electricity, gas, and water account for 2% of GDP. Within the manufacturing sector, food, beverage, and tobacco is the largest subsector in terms of value addition, accounting for 44%. Textiles, apparel, and leather is the second-largest sector with 20% of value addition. The third-largest sector in value added terms is chemical, petroleum, rubber, and plastic products. Agriculture has lost its relative importance to the Sri Lankan economy in recent decades. It employs 35% of the working population, but accounts for only about 12% of GDP. Rice, the staple cereal, is cultivated extensively. The plantation sector consists of tea, rubber, and coconut; in recent years, the tea crop has made significant contributions to export earnings. Domestic agriculture such as rice and other food crops is expected to improve significantly with the return of peace to the eastern and northern provinces. Trade and Foreign Assistance Sri Lanka's exports (mainly apparel, tea, rubber, gems and jewelry) are estimated at $8.1 billion and imports (mainly oil, textiles, food, and machinery) were estimated at $14 billion for 2008. The resulting large trade deficit was financed primarily by remittances from Sri Lankan expatriate workers, foreign assistance, and commercial borrowing. Sri Lanka must diversify its exports beyond garments and tea. Garment exports face increased competition since the 2005 expiration of the worldwide Multifiber Arrangement. Sri Lanka's exports to the European Union (EU) increased sharply in 2006-2008 due to duty-free entry of goods under the EU GSP Plus program, granted in 2005 to help Sri Lanka rebuild after the 2004 tsunami. The GSP Plus program expired at the end of 2008 and was temporarily renewed subject to an investigation on human rights practices. The tea industry is challenged by a shortage of plantation labor and by growing competition.

Exports to the United States, Sri Lanka's most important single-country market, were estimated to be around $2 billion for 2008, or 25% of total exports. As a result of the GSP Plus program, the EU as a whole is Sri Lanka's biggest export market. For many years, the United States has been Sri Lanka's biggest market for garments, taking almost 50% of total garment exports. India is Sri Lanka's largest supplier, accounting for over 20% of imports. United States exports to Sri Lanka were estimated to be around $280 million for 2008, consisting primarily of wheat, electrical apparatus, textiles and specialized fabrics, medical and scientific equipment, plastics, and paper.

Sri Lanka is highly dependent on foreign assistance, with the World Bank, the Asian Development Bank, Japan, and other donors disbursing loans totaling $1.4 billion in 2007. Iran is becoming the largest provider of foreign assistance. During the Iranian President's visit in April 2008, Iran committed $450 million for the Uma Oya multipurpose irrigation project. Iran is also a major lender to Sri Lanka and has provided infrastructure project loans and an interest-free credit facility for oil imports. Under this facility, Sri Lanka has imported substantial amount of oil (valued at $700 million as of June 30, 2008). Iran promised assistance for modernization of Sri Lanka's only oil refinery, though no firm commitments are in place. China has also become a major lender for infrastructure projects, such as a new port and a coal power plant. Foreign grants amounted to $275 million in 2007. While implementation of aid projects has been spotty over the years, the government is trying to improve this record by streamlining tender processes and increasing project management skills. In the 19th and 20th centuries, Sri Lanka became a plantation economy, famous for its production and export of cinnamon, rubber and Ceylon tea, which remains a trademark national export. The development of modern ports under British rule raised the strategic importance of the island as a centre of trade. During World War II, the island hosted important military installations and Allied forces. However, the plantation economy aggravated poverty and economic inequality. From 1948 to 1977 socialism strongly influenced the government's economic policies. Colonial plantations were dismantled, industries were nationalized and a welfare state established. While

the standard of living and literacy improved significantly, the nation's economy suffered from inefficiency, slow growth and lack of foreign investment. From 1977 the UNP government began incorporating privatisation, deregulation and the promotion of private enterprise. While the production and export of tea, rubber, coffee, sugar and other agricultural commodities remains important, the nation has moved steadily towards an industrialised economy with the development of food processing, textiles, telecommunications and finance. By 1996 plantation crops made up only 20% of export, and further declined to 16.8% in 2005 (compared with 93% in 1970), while textiles and garments have reached 63%. The GDP grew at an average annual rate of 5.5% during the early 1990s, until a drought and a deteriorating security situation lowered growth to 3.8% in 1996. The economy rebounded in 19972000, with average growth of 5.3%. The year of 2001 saw the first recession in the country's history, as a result of power shortages, budgetary problems, the global slowdown, and continuing civil strife. Signs of recovery appeared after the 2002 ceasefire which died away following the beginning of war. Since the separatist war ended in May 2009 the Sri Lankan stock market has shown marked gains to be among the 3 best performing markets in the world. The Colombo Stock Exchange reported the highest growth in the world for 2003, and today Sri Lanka has the highest per capita income in South Asia. About 14% of the population live on less than US$ 1.25 per day.