The economic recovery in 2002 was mainly driven by the rising consumer confidence motivated by the ceasefire in early 2002. It is expected that this consumer driven growth will continue further in 2003 and 2004 as well. However, the building up of investor confidence has been slower than that of consumers. Major investors continue to await a firm signal from the ongoing peace process. Meanwhile, the speed of implementation of structural reforms and large-scale infrastructure projects will be crucial for future capital formation and productivity improvements.

Developments in 2003
• In 2002, the economy turned around to positive growth, driven by private consumption expenditure, which grew by 16.6 per cent. The increase in consumption expenditure in 2002 was mainly due to the improved security situation.
This consumption driven growth is expected to continue in 2003.
• Higher production and growth of domestic agricultural incomes have increased demand for consumer durables in that sector. Lower interest and inflation rates have also been stimulating consumer confidence. Hence, two thirds of growth is expected from increased consumer demand. In real terms, consumption expenditure is projected to grow by 5.6 per cent in 2003, whereas the real economic growth is projected at 5.5 per cent.

Investment and Saving Ratios

• Following the previous year’s trend, government consumption expenditure is projected to decline further due to fiscal consolidation. As government current expenditure is expected to be streamlined in the long term, future growth in aggregate demand will have to come largely from the private sector.
• Although the cessation of hostilities has boosted consumer confidence, it is evident that investors are awaiting firmer signals from the peace process. The investment/GDP ratio, which declined to 22 per cent in 2001 from 28 per cent in 2000, deteriorated further to 21.3 per cent in 2002 even though economic growth turned around from negative to positive. In 2003, the ratio is expected to rise to 22.3 per cent. The slow recovery in private investment and a shortfall in government investment under severe budgetary constraints are likely to contain investment expenditure.

Investment and Enterprises in Commercial Operation in Board of Investment of Sri Lanka.

Year	No of Units	Foreign Investment Rs. Million
	Approvals	Agreement	Approvals	Agreement
1990	37	16	3,356	1,073
1991	79	52	9,407	4,327
1992	299	154	22,556	18,725
1993	462	324	23,850	13,243
1994	282	268	18,713	25,444
1995	219	138	14,722	6,704
1996	(b)246	135	34,566	22,429
1997	321	(c)181	44,971	28,105
1998	(d)405	230	60,720	25,869
1999	350	205	57,499	40,365
2000	333	204	25084	18407
2001(a)	262	149	30606	8408

Total Envisaged Investment Rs. Million		Realized Investment Rs. Million As at end year	No. of Units in Commercial Production As at end of Year
Approvals	Agreement
4,617	1,344	17,760	127
11,624	5,054	21,586	150
39,089	30,104	26,723	206
52,842	30,698	36,257	357
44,473	51,006	59,809	507
32,310	15,544	72,219	784
59,206	39,451	96,222	866
72,228	39,895	118,997	996
104,045	47,121	151,207	1,158
104,851	62,086	176,019	1,293
84622	44829	194,726	1372
55285	51682	208079	1378

• The private investment/GDP ratio has steadily grown since 2001, when the ratio was 16.2 per cent. In 2002, the ratio improved to 16.7 per cent, and it is expected to be 17.2 per cent in 2003. Private sector investment has been mainly concentrated in power generation, telecommunications, transport and retail trading. The growth in private investment in 2003 was lower than originally expected because of slow investor response and excess capacity in some sectors. In particular, the export manufacturing and tourism sectors, though they performed well in the first half of 2003, still had excess capacity.

• In 2003, domestic savings, as a ratio of GDP, are projected to increase marginally from 14.5 per cent to 14.6 per cent. This is owing to a reduction in government dis-savings which thereby reduced its negative impact on domestic savings. Government dis-savings (a situation where government’s consumption is higher than its revenue), which were 4.4 per cent of GDP in 2002, are expected to decline to 3.1 per cent, due to discipline in budgetary performance. Private savings are projected to increase by 5.6 per cent in 2003, compared with 2.5 per cent in 2002. The private savings/GDP ratio is expected to decline however in 2003, as GDP at current market prices is projected to grow faster than private savings. Meanwhile, the gap between savings and investment, as a ratio of GDP, is expected to increase marginally, as the investment ratio is projected to grow faster than the domestic savings ratio.

Outlook for 2004
• In 2004, consumption expenditure is predicted to rise further with expected economic growth. The improvement will depend on increased demand by households and the organised private
sector, as the continued streamlining of public expenditure will contain expansion in public consumption. Of the projected demand growth, over 70 per cent is expected to come from increased consumption expenditure.
• The anticipated upturn in global economic activities is expected to create a higher demand for exports in 2004. Consequently, increasing derived demand for intermediate goods for the export sector and the expected growth in the domestic economy in 2004 will also raise the demand for imports.
• Investment in 2004, is expected to rise to around 24 - 25 per cent of GDP because of improved business confidence, better performance of equity markets, lower interest rates and a higher level of foreign investment. It is expected that the private sector will be largely responsible for this improvement. However, this is lower than the 30 per cent of GDP required to accelerate economic growth to about 8 per cent.
• Capital formation was below expectations in 2003. The latest projection for 2004 is lower than expected earlier. Those shortfalls raise concerns, as they impact directly on future economic growth and the creation of employment opportunities. Future economic growth and employment creation will ultimately depend on two critical factors that crucially affect future capital formation: first, the speed of implementing structural reforms and large scale projects that are already in the pipeline to provide infrastructure facilities needed to stimulate private investment, and second, finding a durable solution to the civil conflict.
• Domestic savings are expected to rise in 2004, mainly benefiting from an increase in incomes and a decline in government dissavings. The resource gap, i.e., the savings-investment gap as a ratio of GDP is expected to remain at the same level in 2003, as both investment and savings are projected to rise by the same factor.

Foreign Investment:
• Net foreign direct investment inflows for 2003 have been estimated at US dollars 226 million. The number of BOI agreements signed during the first half indicates that actual inflows could exceed expected inflows.
• Portfolio investment continued to record net positive inflows during the first half of 2003, continuing the trend experienced after the ceasefire and reflecting the relatively stable political
environment. Net inflows in the first eight months amounted to about US dollars 30.42 million. However, the trend has reversed in September with the purchase of hotel share (worth of about US dollars 40 million) by a domestic blue chip company from foreign investors. Capital Inflows to the Government.
• Credit inflows to the government, which are mostly on concessional terms, have been higher than expected so far in 2003, mainly due to faster implementation of foreign funded projects and receipt of a significant amount of programme loans and some aid for flood relief as budgetary support from donors.
• The amount of loans and grants disbursed to the government during the first 7 months of the year was around US dollars 500 million including programme loan inflows of US dollars 178 million. With the expected programme and project loan inflows during the balance part of the year, foreign financing for the year is likely to exceed the original expectation of US dollars 865 million.
• Meanwhile, repayments of government external debt during the first half of 2003 decreased to US dollars 167 million from US dollars 177 million paid during the corresponding period in 2002, mainly due to lower re-payment obligations related to defence loans.
• The donors at the Tokyo Conference in June 2003 pledged US dollars 4.5 billion of new commitments for the four year period 2003-2006.

Overall Balance of Payments
• Summing the favorable developments in trade, services, transfer and income accounts, the current account deficit remained low at US dollars 58 million during the first half of 2003. The surplus of US dollars 340 million in financial and capital accounts was more than sufficient to offset this deficit and result in a surplus of US dollars 187 million in the overall BOP during the first half of 2003.

Revised annual BOP estimates for 2003 indicate a lower current account deficit of US dollars 416 million (2.3 per cent of GDP) than the original estimate of US dollars 588 million reflecting faster recovery in exports and tourism and high growth in private transfers. This lower current account deficit, together with net increases in capital and financial accounts, is expected to lead to an overall BOP surplus of US dollars 390 million in 2003, the third consecutive year of surplus.

Gross Official Reserves
• Official reserves continued to build up at a faster rate during the first eight months of the year than the corresponding period in 2002. Gross official reserves at the end of June 2003 amounted to US dollars 1,978.5 million. This has increased to US dollars 2,064.7 million by end August, sufficient to cover 3.8 months of imports, compared to the 3.1 months of imports as at end August 2002.
• The signing of the Poverty Reduction and Growth Facility/Extended Fund Facility (PRGF/ EFF) with the IMF and related PRSC from the World Bank resulted in a disbursement of US dollars 80 million and US dollars 47.5 million (Out of US dollars 127.5 million disbursed to the government.) respectively, which helped to build up official reserves. In addition, programme loan disbursements from Japan and India added another US dollars 70 million to gross official reserves. Liquidity available in the forex market due to a surplus in the BOP enabled the Central Bank to purchase US dollars 155 million in the first half and US dollars 333 million during the first nine months of the year.

Exchange Rate

• Under the independently floating exchange rate regime, the exchange rate continued to be relatively stable while moving broadly in line with inflation differentials between Sri Lanka and its trading partner countries up to end of August 2003. However, in September, the exchange rate against the US dollar appreciated, resulting in some volatility in the exchange rate. This partly reflects an over reaction to a slight appreciation of the rupee by market participants.

Nominaland Real Effective Exchange Rates

• The US dollar/rupee rate remained stable, varying between Rs.96.64 and Rs.97.28 per US dollar during the first eight months of the year. The rupee depreciated against the US dollar by 0.4 per cent in the first half and appreciated by 2.4 per cent during the first nine months, compared with a depreciation of 3.7 per cent during 2002. The international weakness of the US dollar, increased foreign exchange inflows
to Sri Lanka and relatively slower expansion in imports contributed to the relative stability of the rupee against the US dollar. The US dollar weakened against most major currencies in the international market during the first nine months of 2003 rehabilitation and reconstruction work.
• The surplus in the services account is expected to improve at a steady rate of 8 to 9 per cent. Higher tourist arrivals and increased inflows from port related services are expected to contribute to these improvements.
• The deficit in the income account may increase marginally as global interest rates are expected to be higher in 2004.
• Even though the surpluses in the services and transfers accounts are expected to increase in 2004, the current account deficit is expected to widen to 2.9 per cent of GDP in 2004 from 2.3 per cent in 2003 due to the larger trade deficit.
However, this increase would not be a serious concern as it is driven by investment related imports and funded by foreign capital inflows, which can move the country to a higher growth path in the medium term.
• In the capital and financial accounts, loan disbursements to the government are expected to exceed US dollars 1 billion, including programme loans of about US dollars 370 million in 2004. Capital inflows to the private sector in terms of FDI, loan capital and portfolio investments are projected to increase in 2004 with progress in the peace process and improving investor confidence.
• As a result of these developments, the surplus in the capital and financial accounts will increase, more than offsetting the rise in the current account deficit. Consequently, the addition to both official reserves and total reserves is expected to continue in 2004.

Growth in Industrial Output

Composition of Industrial Production

Production in Major Industrial Sub Sectors

Output Growth in Textiles, Apparel and Leather

Output Growth in Food, Beverages and Tobacco

Output Growth in Chemical, Petroleum, Rubber

Output Growth in Non-Metalic Mineral Products

Public Investment 2003 - 2007

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