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The Sri Lankan rupee has performed surprisingly quite well considering the domestic chaos from the civil war due to the fact that Sri Lanka has a progressive and open economy resulting in steady gradual economic growth. Sri Lanka with a population of 19.6 million is located just south of India in the Indian Ocean. Since gaining independence from the United Kingdom in 1948, Sri Lanka has made great progress transforming from reliance on an agricultural based economy to a shift towards middle income nation status diversifying into higher paid industries such as insurance & banking. Unfortunately, the nation has been held back financially by a 20 year ethnic civil war between the Sinhalese majority (75 pecent) and the Tamil Tiger separatists that positions government military forces against guerilla Tiger rebels. The Tamil Tiger's who control much of the north and east of Sri Lanka have approximately 2 million people living under their control.

POLITICS: Prime Minister Wickremesinghe of the reformist business-backed United National Party took power in December 2001 after his election victory over President Chandrika Kumaratunga who now is head of the main opposition party. The civil war is front and centre of issues for Sri Lanka and Wickremesinghe's election campaign centred on his promise to make peace with the Liberation Tamil Tigers of Eelam (LTTE) formed in 1976. LTTE is a rebel insurgency group fighting for an independent homeland for areas under their control. The Tigers have claimed that they have been victims of systematic discrimination by the Sinhalese majority. Resolving this crisis will provide for a stronger and wealthier Sri Lanka, it appears that the conflict is getting close to coming to a close as September 2002 peace talks in Thailand were successful and new talks scheduled shortly look very encouraging. This bloody civil war has given Sri Lanka a scarred history of political violence as several high profile politicians have been assassinated including President Premadasa who was killed in a bomb explosion in 1993 in the capital of Colombo.

A cease-fire was declared in early 2002 resulting in a cessation of civil violence. Arbitrators from other countries have presented speakers and consultants who are advising both the government representatives from Colombo and Tamil Tiger negotiators about model constitutions of other successful Federal states including that of Switzerland, Spain and Canada. A future Sri Lanka will most likely consist of an extensive power sharing arrangement with decentralized powers given to the Tamil Tiger region similar to that of Canada resulting in a unified Sri Lanka rather than two separate countries. More importantly, Sri Lanka does indeed have significant upside economic potential to achieve a much higher standard of living similar to countries like Switzerland and Canada where their constitution creates political stability, a necessity for wealth creation. During December 2002 peace talks, the Tamil's dropped their demands for an independent state as they welcomed the idea of regional autonomy and extensive self-rule within the framework of one country.

ECONOMY: in 1977, the government in Colombo (capital of Sri Lanka) changed course and began the process of transforming to a free market open and export-oriented economy from a previous closed socialist command control ideology. Sri Lanka has sustained economic growth resulting in diversification into higher income industries advancing Sri Lanka to middle income nation status: banking, tea exports, diamonds, rubber, textiles, food processing, telecommunications and manufacturing. The fiscal deficit is a problem resulting in higher real interest rates to offset exchange rate and inflationary pressures. Sri Lanka has preferred geographical location near international shipping lanes in the Indian Ocean. The United States is Sri Lanka's largest export market. The economy is forecasted to rebound in 2003 with 2nd half 2002 showing a brisk pick up in GDP growth. Year 2001 was Sri Lanka's first economic contraction since independence 55 years ago when GDP growth fell 1.3 percent. The recession was attributed to the civil conflict and higher defense outlays creating budgetary difficulties, power shortages resulting from drought for hydropower electricity required for industry and the global recession.

Economic Statistics
GDP at $62.7 billion USD (2001) and GDP/capita at $3,250 USD (2001). Average GDP growth for 1997 to 2000 came in at 5.5 percent. Year 2002 GDP growth came in at around 3.5 percent. Inflation from 1997 - 2001 averaged at 2.3 percent although 2001 came in moderately high at 14 percent due to Sri Lanka's economic contraction. Year 2002 inflation was measured at 9 percent. The fiscal budget deficit is a serious difficulty with 2001 deficit at 11 percent of GDP and 2002 slightly better at 9 percent. The current account is in deficit with 2001 at 2.4 percent, 2000 at 6.5 percent directly attributed to Sri Lanka's trade deficit of $1 billion USD per year and higher. The capital account is in surplus from remittances, foreign aid and government borrowing. Unemployment is at 8 percent although the size of the underground economy is quite large estimated at $3 billion USD. Sri Lanka's stock market during year 2002 was one of the world's best performing markets reflecting the hope for sustained peace.

POSITIVE: extensive hydropower, well-educated nation. CONCERN: poverty at 20 percent, minimal fossel fuel energy. Sri Lanka is a net energy importer, particularly in oil of which sustained high world oil price will impact Sri Lanka's current account net position, large inefficient public sector.

BANKING SYSTEM: gross official reserves are low as year-end 2001 were valued at $1.2 billion USD. The banking system is quite healthy. The Central Bank of Sri Lanka (CBSL) is in charge of the nation's monetary policy and monitoring the exchange value for the Sri Lankan rupee. Reserve adequacy by comparing net reserves and their ability to cover short-term debt requirements is an important measure as many currency crashes are caused by difficulties in the capital account. Sri Lanka's low reserve position keeps the Sri Lankan rupee vulnerable to economic shocks.

A free trade agreement with India, a regional superpower was signed in 2000 as this is instrumental considering India's high growth economy and massive market with over 1 billion consumers.

KNOWLEDGE: the Tamil Tiger rebels have de facto control of the northern third of Sri Lanka. Since the ethnic conflict and civil war between the minority Tamils and government forces; over 200,000 Tamils have taken political asylum in the West with another 100,000 Tamils displaced although many of these are now finally returning to their homes with current peace talks getting close to settlement. Over 64,000 have been killed in the 20 year civil war coupled with the fact the war has reduced GDP by an estimated 25 percent during this time. Peace would improve business confidence and thus lower defense spending requirements and redirect funds towards necessary social & infrastructure spending. The civil war has held back economic growth and development for Sri Lanka with low foreign direct investment (FDI) levels, few tourist visits as suicide bombers have scared away foreigners and general malaise.

Peace will indeed bring an economic peace dividend but not for a few years as a large amount of infrastructure and telecommunications networks have to be rebuilt and explosive mines have to be cleared from several war regions. Badly needed FDI will return to Sri Lanka resulting in higher GDP growth rates estimated annually at 5 to 7 percent. Once peace if finalyzed, Sri Lanka may want to consider taking advantage of its strategic location and promote itself as an offshore banking haven to those consumers in India by implementing private banking and other global financial services demanded by a growing wealthy global clientele.

ISO symbol 'LKR', Sri Lankan rupee. At time of review on Janaury 21, 2003, the Sri Lankan rupee had an exchange value of 96.64 LKR to 1 USD.

CURRENCY HISTORY: over the last several years, the LKR has had steady but stable depreciation under a crawling exchange peg regime as Sri Lanka was facing large import bills and a low net foreign reserves. The Sri Lankan rupee was floated on January 23, 2001 in order to help reduce the current account deficit and increase the country's net reserve position. Historical quotes for the LKR include year 1997 at 58.9 LKR to 1 USD, December 1998 at 68.09, December 1999 at 71.82, December 2000 at 81.98, December 2001 at 93.05, December 2002 at 96.57.

CURRENCY FORECAST: appreciation to the USD once peace finalyzed. Further currency gains possible if Sri Lanka establishes itself as an offshore private banking centre that positions Sri Lanka as a regional financial centre benefitting from higher paid services jobs. A rebound in GDP growth rates from the peace dividend will improve all macro-economic fundamentals. Labour reforms, industry privatizations and a reduction in the bureaucratic public sector will futher help to strengthen Sri Lanka's economy and currency, the LKR. For further information on the Indian rupee, please click INDIA in this BI.C currency index. UPDATED: January 21, 2003

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