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US-EU recession would hit Sri Lanka -Dr. Sirimal Aberathne

Dr. Sirimal Aberathne of the Department of Economics, University of Colombo said that the adverse impact of the EU recession on the Sri Lankan economy would be widespread and Sri Lanka will have to downgrade its anticipated growth targets.

Growth forecasts for the Euro Zone have been revised downward in the backdrop of the worsening sovereign debt crisis in the region. Most countries in the Euro Zone began to violate their policy coordination through increased borrowings. When the private sector becomes weaker, the government has to be stronger to mitigate the adverse impact of economic recessions.

Yet the theory does not seem to have worked that well, as investor confidence deteriorated and growth slowed down re-enforcing each side. The attempts of the European Central Bank to prevent the forthcoming recession have so far been ineffective. And, above all it is a new dimension of business cycles as Euro Zone is an “alliance” of countries, which established a single currency (Euro) after agreeing to work together.

They will have to integrate even more by surrendering policy autonomy. If not the challenge is how to defend the Euro, which would come under increasing pressure for disintegration.

Euro recession, apparently quickly spread to US because the EU and the US are integrated intensively through trade, investment and financial flows much more than the other regions in the world.

For that matter the two regions share a large part of the world income and consumption.

Developing countries such as Sri Lanka are integrated with the US and EU through trade, investment and tourism. Since Sri Lanka does not have a deeper financial integration, the US-EU recession would affect the country mainly through the real sector.

Sri Lanka’s exports share to US and EU account for nearly 60 percent of total exports.

As the recession could affect many other countries which are integrated to US and EU, and which are having economic relations with Sr Lanka, the adverse impact of the EU recession on the Sri Lankan economy would be widespread, he said.

Is 8% growth target a realistic or do we need a downward revision?

Dr. Aberathne said that Sri Lanka will have to downgrade its anticipated growth targets. Sri Lanka’s growth outlook in the recent past has moved in a peculiar path.

As a “small economy”, Sri Lanka’s growth must be reflected in its trade performance.

Yet during the past few years, Sri Lankan trade volume as a percentage of GDP has declined sharply, despite rapid economic growth.

Moreover, Sri Lanka’s export share to US has declined already, while its decline has been replaced by rising share of exports to EU.

With recession, the rising trade share of the EU would be under pressure. In addition, Sri Lanka’s trade diversification has not been satisfactory, so that our exports to the rest of the world grew slowly.

Against this backdrop, the negative impact of a possible Euro recession is likely to be dramatic.

Coincidently, the changes in development strategies and the role of the government during the past few years were, helpful in mitigating the medium-term adverse impact of the US recession.

Yet, the sharp changes in the policy regime, as clearly anticipated at the time, raised the important issues of their long-term sustainability and macroeconomic costs which the country is facing right now.

Therefore, if the EU crisis deepens Sri Lanka could have a double blow, one external and the other internal, he said.

GW

 

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