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Q+A-Whither Sri Lanka’s post-election economy?

[Reuters, Thursday, 8 April 2010 12:52 No Comment]

Newly re-elected Sri Lankan President Mahinda Rajapaksa was expected to cement his dominance at parliamentary polls on Thursday, with his ruling alliance heavily favoured to win a majority. [ID:nSGE637028]

Once the new parliament sits, it will be almost a year since Rajapaksa declared victory in a three-decade war over the Tamil Tiger rebels. So with political jostling out of the way, the focus will turn to the island nation’s $42 billion economy.

Here are some questions and answers on what to expect:

WHAT ECONOMIC POLICIES WILL RAJAPAKSA PURSUE?

Rajapksa’s election manifesto is the main policy guideline for his ruling alliance, and it aims to return Sri Lanka to its former status as a major Asian hub. Economists say the manifesto has some contradictory elements, so what Rajapaksa brings to parliament in the 2010 budget, expected in May, will be the first concrete signal.

WHAT ARE THE EARLY SIGNS?

Rajapaksa’s first post-war priority has been spending on big infrastructure projects like power plants, highways and the ambitious construction of the Hambantota port on the island’s southern coast, funded with a $1 billion loan from China.

The port is in Rajapaksa’s home district, and near one of the world’s busiest shipping lanes and along an old "Silk Road" route.

That project comes along with other infrastructure and agricultural development programmes across the island, including the former war zone in the north and east.

Most projects are government-run, the sign of a growing public hand in the economy. Already, the government has moved to reverse privatisations carried out by the preceding administration.

WHAT ABOUT GOVERNMENT SPENDING?

Sri Lanka has long had many state companies and a bloated public sector, a relic of its socialist roots which remains a powerful patronage tool. That leads to massive government spending and borrowing — to wit, Sri Lanka recorded a 9.8 percent budget deficit in 2009.

That was well above the 7 percent target the International Monetary Fund (IMF) laid down. Signalling things will not improve as fast as the lender envisioned, the Central Bank this week said it would renegotiate those targets. If it doesn’t, the IMF loan that boosted Sri Lanka’s credit rating could be suspended.

WILL THERE BE FISCAL REFORMS TO ATTRACT INVESTMENT?

Yes. Analysts say Rajapaksa will be compelled to look into fiscal, tax and other reforms in the next budget to meet the IMF targets. The expectation is that the budget will focus on revenue enhancement and expenditure reduction.

Economists also expect some reforms to trim bureaucracy that makes doing business difficult, and work to ease an effective corporate tax rate the World Banks says is 61 percent.

WHERE IS THE ECONOMY HEADING POST-POLL?

Economists say Sri Lanka has a natural growth rate of 6 percent a year barring internal or external shocks, but could hit 8-9 percent with proper policy and regulatory frameworks.

The central bank forecasts 6.5 percent this year, and 7.5 percent or higher in 2011-2013.

AND THE STOCK AND BOND MARKETS?

The Colombo Stock Exchange .CSE keeps pushing further into record turf, having surged 162 percent since 2009. But foreign investors have been net sellers, cashing in long-awaited profits.

The market is expected to keep trending upward broadly, but will struggle for long-term growth until the free float available in it expands, analysts and investors say.

Most new offshore investors have shown strong interest only in lower-risk, higher-yield instruments like government securities and sovereign bonds. Sri Lanka expects to issue a third sovereign bond, for 10 years and $500 million, in the second half of 2010.

The popularity of government securities means Sri Lanka has to maintain attractive yields — the benchmark 91-day T-bill yield is 8.52 percent now — and protect its rupee currency against sharp fluctuations, or else foreign money will go.

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