Sri Lanka Overview

Sri Lanka is focusing on long-term strategic and structural development challenges as it strives to transition to an upper middle-income country. Key challenges include boosting investment, including in human capital, realigning public spending and policy with the needs of a middle-income country, enhancing the role of the private sector, including the provision of an appropriate environment for increasing productivity and exports, and ensuring that growth is inclusive.

The Sri Lankan economy has seen robust annual growth at 6.5 percent over the course of 2004 to 2013, well above its regional peers. Following the end of the civil conflict in May 2009, growth rose initially to eight percent, largely reflecting a “peace dividend”, and underpinned by strong private consumption and investment. While growth was mostly private sector driven, public investment contributed through large infrastructure investment, including post war reconstruction efforts in the North and Eastern provinces. Growth closed at 7.3 percent in 2013, driven by a rebound in the service sector which accounts for about 57 percent of GDP. Overall, unemployment at 4.4 is low, although youth unemployment (ages 15-24) at around 19.1 percent and low female labor force participation at 35.6 percent pose a challenge.

Sri Lanka seeks to achieve $4,000 in GDP per capita by 2016, from $3,280 in 2013, but faces three particular macroeconomic challenges. Sustaining an eight percent-plus annual growth to meet this goal will require:

(i) fostering private sector development and greater private investment;

(ii) increasing exports to generate jobs and managing the current account deficit; and

(iii) further addressing fiscal imbalances and reversing the declining trend in revenue collection. Such growth would need to be driven by a high investment rate of above 40 percent of GDP, which seems ambitious given the country’s level of investment of 29.6 percent of GDP in 2013.

Growth will largely depend on fostering private sector development and private investment, especially increased foreign direct investment (FDI). Increasing gross FDI above the 1.4 percent of GDP level achieved in 2013 will be crucial. Streamlining procedures and reducing administrative barriers to FDI will be important in this regard. Sri Lanka will also need to demonstrate sustained commitment to ensuring an attractive investment environment with clear rules of the game applied equally. Sri Lanka’s economy depends on FDI to bring in innovation. The import of FDI is further underscored by the country’s limited domestic savings rate, brought about largely by its demographic trends. Contrary to most economies in South Asia, Sri Lanka does not have a demographic dividend: by 2036, more than 22 percent of the population will be over 60, and there will be 61 dependents per 100 adults. Increases in the labor force, employment rates and productivity will be central to growth. Against the background of an aging society, efficient and well-targeted social assistance will also become more important.

Sri Lanka’s growth and competitiveness are constrained by a skills gap that has emerged with the changing labor market conditions. Sri Lanka’s economy is no longer dominated by the agriculture sector but rather by services, followed by industry and manufacturing. Employment patterns have followed, shifting significantly from agriculture to industry and services. Labor productivity levels need to rise. There is also a mismatch between graduates and private sector needs particularly with regard to “soft skills”. Improving the quality of human capital through effective education and skills development is central to Sri Lanka’s economic growth and competitiveness and to the government’s aspiration of becoming knowledge based economy.

Last Updated: Feb 10, 2015