The Sri Lankan economy registered a growth of 4.4% in
2016, in real terms, in comparison to a growth of 4.8% in 2015.
Services and industry related activities contributed to
economic growth, while unfavourable weather conditions
triggered a contraction in agriculture in 2016. The
unemployment rate declined to 4.4% in 2016 from 4.7% in 2015,
owing to the expansion in industry and services. Despite the
uptick in inflation in certain months due to supply side
disruptions and upward adjustments in the tax structure,
inflation broadly remained at mid-single digit levels.
External sector performance remained challenging during
2016, and some deterioration of the balance of payments was
observed. Inflows to the current account in the form of
earnings from tourism and workers' remittances helped cushion
the larger trade deficit. Direct investment inflows remained
moderate and rising global interest rates resulted in capital
outflows from the government securities market. Although the
exchange rate was broadly stable during the early part of the
year due to intervention by the Central Bank, the exchange rate
was increasingly allowed to reflect market conditions
thereafter. Greater flexibility in the exchange rate is also
expected to improve the competitiveness of the economy.
The fiscal sector witnessed notable improvements with
government efforts towards fiscal consolidation. Accordingly,
budgetary operations improved in terms of revenue and
expenditure, containing the overall budget deficit at 5.4% of
GDP compared to 7.6% in 2015. The broadened tax base, along
with several structural reforms in tax administration,
supported the increase in government revenue, while efforts to
rationalise recurrent expenditure and prioritise capital
expenditure reduced government expenditure. Nevertheless, the
central government debt to GDP ratio edged up to 79.3% in 2016
mainly due to the increase in net borrowings and the modest
economic growth during the year.
The financial sector continued to expand during the year,
whilst exhibiting resilience amidst challenging market
conditions both globally and domestically. The asset base of
the banking sector expanded, while capital and liquidity levels
were maintained well above the minimum statutory requirements.
The Central Bank initiated several measures to strengthen the
supervisory and regulatory framework for financial
institutions. Meanwhile, a regulatory framework for the
microfinance sector was introduced in 2016.
The Central Bank continued to tighten the monetary policy
stance in 2016, in view of possible emergence of demand-driven
price pressures. Accordingly, in addition to the increase in
the Statutory Reserve Requirement in early 2016, policy
interest rates were also increased by a total of 100 basis
points in two steps. Responding to policy measures, monetary
expansion slowed somewhat in 2016, but remained higher than the
envisaged level. Accordingly, the Central Bank further
tightened its monetary policy stance in March 2017. It is
expected that with these measures, money and credit growth will
decelerate to envisaged levels by end 2017.
Moving ahead, monetary policy formulation of the Central
Bank is expected to be based on a Flexible Inflation Targeting
framework to maintain inflation at mid-single digit levels in
the medium term. The continuation of the Extended Fund Facility
(EFF) programme with the International Monetary Fund, while
attracting other non-debt creating financial inflows, would
support the balance of payments and the country's reserve
position. Frameworks being introduced to strengthen
macroeconomic policy making and structural reforms to boost the
growth framework are expected to support a higher growth
trajectory in the medium term.