2013 is the seventh consecutive year that the Central Bank is presenting its policy direction & work

plan for the upcoming period

2

Last years satisfactory results were due to the contributions of many, to whom sincere thanks are due
His Excellency the President, Mahinda Rajapaksa as the Minister of Finance for the excellent leadership and guidance given The Deputy Minister of Finance and Planning, Hon. Dr. Sarath Amunugama and the Former Deputy Minister of Finance and Planning, Hon. Geethanjana Gunawardene for their constant guidance and support The members of the Monetary Board, Dr. P.B. Jayasundera, Secretary to the Treasury, Mrs. Mano Ramanathan, Mr. Nimal Welgama and Mr. Neil Umagiliya for all their assistance, guidance and wise counsel Deputy Governors, Dr. Nandalal Weerasinghe, Mr. Ananda Silva and Mrs. Chandra Premaratne, Assistant Governors, Heads of Departments and all staff of the Central Bank who have worked with dedication, commitment and professionalism to fulfill the mandate of the Central Bank The Consultative Committees on Monetary Policy, the Financial System Stability and all other committees for the policy advice
3

Prior to presenting the policy direction and strategies for 2013 and beyond, a review of the post-conflict period of 2010, 2011 and 2012* would be useful

* Figures for 2012 are provisional

A major growth momentum has been witnessed in the first two years, 2010 & 2011, while a gentle deceleration in growth took place in 2012
% 9.0 8.0 7.0 7.0 6.2 6.0 5.0 4.0 3.0 2.1 2.0 1.0 1.6
2008-Q1 2008-Q2 2008-Q3 2008-Q4 2009-Q1 2009-Q2 2009-Q3 2009-Q4 2010-Q1 2010-Q2 2010-Q3 2010-Q4 2011-Q1 2011-Q2 2011-Q3 2011-Q4 2012-Q1 2012-Q2 2012-Q3 2012-Q4 (Est)

Quarterly Economic Growth

8.5 8.0 7.1 6.3 6.1 6.4 8.6 8.0 8.1 8.5 8.3 7.9 6.8

Peace dividend has been clearly visible Remarkable performances have been witnessed in all key sectors of the economy Business confidence has been enhanced during the 3-year period Benign macro-economic fundamentals have been established across all vital sectors
5

4.8 4.3 4.2

By end 2011, the Sri Lankan economy had recorded remarkable progress amidst global challenges
High Economic Growth Increased level of Investment Low Inflation Decline in Unemployment Buoyant External Trade Tourism on an accelerator Remittances continued to increase Highest FDI recorded Balance of payments Foreign Reserves at comfortable levels Decline in Budget Deficit Decline in Govt. debt /GDP ratio Stable interest rates 8.3% on top of 8.0% in 2010 (First time ever) 29.9% of GDP
Declined to 6.7% (Annual Average) in December 2011 (Longest ever continuous period at single digits)

Historic low at 4.2%

Exports grew by 22.4% and Imports by 50.7% Exports & Imports as a % of GDP: 17.8% & 34.3%, respectively Arrivals increased by 30.8% to 855,975 Earnings increased by over 44% to US$ 830 mn

Grew by 25% to US$ 5.1 bn US$ 1,066 mn

A deficit of US$ 1,061 mn, mainly due to unprecedented import demand

US$ 6 bn at end year (3.5 months of imports) 6.9% of GDP 78.5% compared to 81.9%in 2010 (Lowest in 30 years)
Along with improved business confidence, leading to high credit growth of 34.5%
6

By that time however, the global economy which failed to take off in 2011, had slowed down further in 2012
Real GDP Growth
10 8 6 4 Per cent 2 0 -2 -4 -6 2000 2001 2002
World Advanced economies Euro area Emerging market and developing economies

2003

2004

2005

2006

2007

2008

2009

2010

2011

Source : IMF, WEO Database, Oct 2012

2012

The Sri Lankan economy too, faced heightened global and domestic challenges in 2012

Globally
The European Sovereign debt crisis, Fiscal cliff in the US, etc. Global geo-political uncertainties, Iran sanctions, etc. Persistently high petroleum prices

Locally
Excessive credit demand and high imports Drought conditions that severely affected Agriculture and hydro power generation Heavy rains in the last quarter that disrupted food supplies

To deal with these challenges, several tough policy decisions were implemented at the beginning of 2012
Monetary policy
Increased policy interest rates Placed ceiling of 18% on bank credit expansion; Additional 5% for foreign funds
The Repurchase rate and the Reverse Repurchase rate of the Central Bank raised by 50 bps each

Exchange rate policy

Allowed greater flexibility Curbed speculative behaviour in the Forex market

Fiscal policy
Imposed higher tariffs and excise duties on selected imports

Administered pricing policy

Allowed greater pass-through of Energy and Transport prices

A ceiling on rupee credit growth imposed on Licensed Banks. This was expected to directly impact the intermediate target of the Monetary Policy Framework

The Repurchase rate raised by 25 bps and the Reverse Repurchase rate raised by 75 bps

The Sri Lankan economy showed resilience and adjusted reasonably well to those measures
GDP growth was reasonably strong
10 8 Per cent 6 4 2 0 -2 1976 1977 1978 1979 1980 1981 1982 1983 1984 1985 1986 1987 1988 1989 1990 1991 1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 Dec-10 2011 2012 (E)

Inflation continued to remain in single digits...

35 30 25 20 15 10 5 0 -5 Dec-78 Dec-80 Dec-82 Dec-84 Dec-86 Dec-88 Dec-90 Dec-92 Dec-94 Dec-96 Dec-98 Dec-00 Dec-02 Dec-04 Dec-06 Dec-08 Dec-12

Per cent

10

Inflation continued to remain in single digits...

35 10 30 8 25 20 6

GDP growth was reasonably strong

And, as expected, import expenditure declined

Cumulative expenditure on imports declined by 4.5% during the first 11 months, reflecting declines in:
Consumer goods imports by 17.2% Intermediate goods imports by 3.7%
90 80 70 60 50 40 30 20 10 0 -10 -20 -30 -40 -50

(%)

Contribution to y-o-y change in Imports

Non-oil imports declined by 8.4% Nevertheless, Investment goods imports increased by 4.8%

Consumer goods Intermediate goods Investment goods Other Jan-08 Mar-08 May-08 Jul-08 Sep-08 Nov-08 Jan-09 Mar-09 May-09 Jul-09 Sep-09 Nov-09 Jan-10 Mar-10 May-10 Jul-10 Sep-10 Nov-10 Jan-11 Mar-11 May-11 Jul-11 Sep-11 Nov-11 Jan-12 Mar-12 May-12 Jul-12 Sep-12 Nov-12
%

Imports as a % of GDP: 31.5%

Import Performance (2007 - 2012)
US$ mn 25,000 20,000 15,000 10,000 5,000 0 2007 2008 2009 2010 2011 2011 2012 (Jan-Nov) (Jan-Nov)

Growth in Imports
-40 -20 0 20 40 47.9 41.4 38.0 34.7 30.9 27.9 60 80 66.5 61.3 72.1 68.4 77.9

Aug-11 Sep-11 Oct-11 Nov-11 Dec-11 Jan-12 Feb-12 Mar-12 -3.4 Apr-12 -6.5 -6.4 -1.3 May-12 -15.0 Jun-12 -23.1 -25.1 -15.4 Jul-12 -4.7 Aug-12 -6.8 -25.4 Sep-12 -30.4 -10.0 Oct-12 -11.5 -8.4 Nov-12 -17.2

22.1 20.6 7.8 3.0 13.4

Y-o-Y Growth in Imports Y-o-Y Growth in Imports net of Petroleum

11

At the same time however, export earnings too, declined as a result of weak global demand
Earnings from exports declined due to;
Lower prices of key export items stemming from lower international commodity prices Subdued global demand in major exports markets
US$ mn 700 680 660 640 620 600 580 560 540 520 500 2011 Q1 2011 Q2 2011 Q3 2011 Q4 2012 Q1 2012 Q2 2012 Q3

Agricultural Exports (2011 - 2012 Q3)

Earnings from exports declined by 6.6% in the first 11 months in 2012 However, exports of mineral products increased by 68.1%
Industrial exports by 7.5% Agricultural exports by 8.7%

Exports as a % of GDP: 16.5%

Export Performance (2007 - 2012)
US$ mn 12,000 10,000 8,000 6,000 4,000 2,000 0 500 2,000 1,500 1,000 US$ mn 2,500

Industrial Exports (2011 - 2012 Q3)

2007

2008

2009

2010

2011

2011 (Jan-Nov)

2012 (Jan-Nov)

0 2011 Q1 2011 Q2 2011 Q3 2011 Q4 2012 Q1 2012 Q2 2012 Q3

12

More importantly, the trade balance contracted

The cumulative deficit in the trade account declined by 2.1% to US$ 8,583 mn during the first eleven months of 2012 from the corresponding period of 2011. Deceleration in the growth in the trade balance was driven by declining expenditure on consumer and non-oil intermediate goods imports.

Trade Balance
0 -200 -400 US$ mn -600 -800 -1000 -1200 Mar May Nov Aug Feb Sep Apr Jun Jan Jul Oct Dec

2011 2012

Trade deficit is expected to contract to 15.1% of GDP in 2012, from 16.4% in 2011
13

As a result of the contraction of the trade deficit and the increase in other earnings, the current account deficit reduced substantially in 2012
Other inflows to the Current Account Tourism on an accelerator Workers remittances continued to bring in substantial foreign exchange Trade in services improved with BPO and KPO sectors gathering momentum
0 -2 -4 US$ bn -6 -8 -10 -12 2007 2008 2009 2010 2011 2012 P Trade Balance Current Account Balance Current Account Balance as a % of GDP (Right Axis)

Trade Balance and the Current Account Balance

0 -2 -4 -6 -8 -10 -12 Per cent

Accordingly, the current account deficit is expected to reduce to US$ 3.3 bn or 5.5% of GDP in 2012, down from 7.8% in 2011.
14

Leading to the Balance of Payments recording a surplus in 2012

BOP Overall Balance
3.0 2.5 2.0 1.5 1.0 US$ bn 0.5 0.0 -0.5 -1.0 -1.5 -2.0 2007 2008 2009 2010 2011 2012 P

The BOP improved from a deficit of US$ 1,061 mn in 2011, to a surplus of over US$ 100 mn in 2012 The BOP is expected to strengthen further in 2013 and beyond, with the gradual recovery of trading, services and investment partners across the globe

15

During the year, higher policy rates, credit ceiling & lower levels of liquidity led to higher market interest rates, curtailed rapid increase in credit & checked import demand
15 13 11 Per cent 9 7 Jan-11 Feb-11 Mar-11 Apr-11 May-11 Jun-11 Jul-11 Aug-11 Sep-11 Oct-11 Nov-11 Dec-11 Jan-12 Feb-12 Mar-12 Apr-12 May-12 Jun-12 Jul-12 Aug-12 Sep-12 Oct-12 Nov-12 Dec-12 5

Movement of Selected Market Interest Rates

Repo Rev Repo Monthly AWPR AWDR AWFDR

Growth in private sector credit, which increased rapidly since the latter part of 2010 and continued until Q1 2012, declined thereafter
80 Rs. bn 60 40 20 8.5 33.7 24.1

14 12 Per cent 10 8 6

Treasury Bill Rates and Policy Interest Rates

Repo Reverse Repo 91- Day Treasury bill 364- Day Treasury bill

Credit granted by Commercial Banks to the Private Sector

60.2

40 Per cent 30 20 10 0 -10

18-Dec-11

23-Mar-11

17-Mar-12

12-Dec-12

6-Feb-11

19-Sep-11

1-Feb-12

13-Sep-12

7-May-11

21-Jun-11

1-May-12

3-Nov-11

5-Aug-11

(20) Jan-09 Mar-09 May-09 Jul-09 Sep-09 Nov-09 Jan-10 Mar-10 May-10 Jul-10 Sep-10 Nov-10 Jan-11 Mar-11 May-11 Jul-11 Sep-11 Nov-11 Jan-12 Mar-12 May-12 Jul-12 Sep-12 Nov-12
Monthly change in credit (Absolute terms)

15-Jun-12

30-Jul-12

28-Oct-12

Growth of credit (y-o-y)

16

Movement of Selected Market Interest Rates

15 13 Per cent 11 9 7

However, in spite of significant price revisions, credit to public corporations increased in 2012
Credit to public corporations increased by around Rs.63 bn. Bulk of the increase was due to credit extended to CEB and CPC, as a result of:
CEBs reliance on thermal power generation due to erratic weather patterns and continued drought. CEBs increased cost of generation and the re-imposition of the FAC did not offer sufficient relief to cover costs.
Rs. bn

Electricity Generation (GWh)

9,000 7,500 6,000 4,500 3,000 1,500 2012 (Proj) 261 198 145
713

2000

2001

2002

2003

2004

2005

2006

2007

2008

2009

2010

Hydro

Thermal

Credit Obtained by Government Corporations

300 250 200 150 100 50 Mar-10 Mar-11 Mar-12 Nov-10 Nov-11 May-10 May-11 May-12 Nov-12 Jul-10 Jul-11 Sep-10 Sep-11 Jul-12 Sep-12 Jan-10 Jan-11 Jan-12

CPC selling fuel at a loss to the transportation sector, and supplying fuel to CEB for electricity generation at well below cost.

Net Credit to Government (NCG) also increased during 2012

The increase in NCG by Monetary Authorities was around Rs. 3 bn during 2012. The increase in NCG by LCBs is estimated to have been around Rs.142 bn during 2012.
CBSL Treasury bill holdings and Provisional advances to the Government
400 350 300 Rs. bn 250 Rs.bn 200 150 100 50 Feb-10 Feb-11 Feb-12 Jun-10 Jun-11 Dec-09 Dec-10 Dec-11 Jun-12 Aug-10 Aug-11 Aug-12 Dec-12 Oct-10 Oct-11 Apr-10 Apr-11 Apr-12 Oct-12 Provisional Advances Treasury Bill holdings

NCG by Licensed Commercial Banks (LCBs)

750 700 650 600 550 531 500 450 400 Dec-09 Feb-10 Apr-10 Jun-10 Aug-10 Oct-10 Dec-10 Feb-11 Apr-11 Jun-11 Aug-11 Oct-11 Dec-11 Feb-12 Apr-12 Jun-12 Aug-12 Oct-12 Dec-12 (est)
550 571

2011

17

18

The banking sector utilised funds raised from abroad to facilitate domestic economic activity, resulting in a decline in Net Foreign Assets (NFA)
NFA of the banking system declined significantly by around Rs.122 bn during the first eleven months of 2012, following the decline in NFA of commercial banks.
Net Foreign Assets (NFA)
600 500 400 300 200 Rs. bn. 100 0 -100 -200 -300 -400 -500 Nov-10 Nov-11 Mar-10 Mar-11 May-10 May-11 Mar-12 May-12 Nov-12
Nov-12

Jul-10

Jul-11

Sep-10

Sep-11

Jul-12
Jul-12

This decline was a reflection of the shift in commercial banks foreign assets to domestic assets.

NFA of Monetary Authorities NFA of the Banking System

NFA of Commercial Banks

19

Monetary expansion was subdued and reached the targeted levels by end 2012
Broad money growth, year-on-year (y-o-y), was expected to decline to 16.2% by end December 2012, from a peak of 22.9% in April. Reserve money growth was in line with the projected path for 2012
Y-o-Y Growth of M2b (%) Month January February March April May June July August September October November December 2011 16.7 17.7 17.5 18.4 19.4 20.7 20.7 20.6 20.7 19.8 20.6 19.1 2012 20.1 21.9 22.8 20.9 20.5 19.8 20.2 18.9 18.2 18.1 16.2 (proj)
Per cent 50 30 10

Growth of Broad Money (M2b)

24 22 20 Per cent 18 16 14 12 10 Dec-11 Mar-12 May-12 Nov-12 Aug-12 Dec-12 Feb-12 Jul-12 Sep-12 Jun-12 Jan-12 Apr-12 Oct-12

Contribution to Year-on-year growth of M2b

22.9

-10 -30
May-10 May-11 May-12 Mar-10 Mar-11 Mar-12 Jul-10 Jan-10 Jan-11 Jul-11 Sep-10 Sep-11 Jan-12 Nov-10 Nov-11 Sep-12

Net Foreign Assets Credit to Public Corporations Other Items (net)

Credit to the Private Sector Claim on Government (net) Broad Money (M2b) growth

20

Sep-12

Jan-10

Jan-11

Jan-12

10

As a result, it was possible to maintain inflation at single digit levels during the year (and cumulatively for 47 months), although supply side pressures were severe
Inflation moved upwards during the year mainly due to:
Supply disruptions on account of drought conditions Upward adjustments of several administratively determined prices Upward duty revisions of several imported items Pass-through of the depreciation of the rupee High credit expansion in the past Movement of Headline and Core Inflation Low base that prevailed in 2011 10
9 8 7 6 5 4 3 2 1 0

9.2 7.6

Annual average: 7.6% in Dec. 2012 Year-on-year: 9.2% in Dec. 2012

Annual average: 5.8% in Dec. 2012 Year-on-year: 7.6% in Dec. 2012

Towards the end of the year, with the tight monetary policy attaining the expected stabilisation objectives, some relaxation measures were possible and were effected
Repurchase rate and the Reverse Repurchase rate were reduced by 25 basis points in December 2012 Announcement was made that the credit ceiling will be allowed to expire at the end of 2012 These measures are expected to stimulate the economy to return to a higher growth path this year while maintaining inflation around the targeted levels.
22

Dec-10 Jan-11 Feb-11 Mar-11 Apr-11 May-11 Jun-11 Jul-11 Aug-11 Sep-11 Oct-11 Nov-11 Dec-11 Jan-12 Feb-12 Mar-12 Apr-12 May-12 Jun-12 Jul-12 Aug-12 Sep-12 Oct-12 Nov-12 Dec-12 Headline (Y-o-Y) Core (xFFET+ RC) (Y-o-Y) Headline (Annual Avg.)

Core Inflation

Per cent

Headline Inflation

21

11

The multi-pronged policy package in early 2012, helped the economy get back on track swiftly, and to record the shortest tightening cycle since 2001
Key Policy Interest Rates
25

20

15 Per cent

10

0 Jan-01 Jul-01 Jan-02 Jul-02 Jan-03 Jul-03 Jan-04 Jul-04 Jan-05 Jul-05 Jan-06 Jul-06 Jan-07 Jul-07 Jan-08 Jul-08 Jan-09 Jul-09 Jan-10 Jul-10 Jan-11 Jul-11 Jan-12 Jul-12 Dec-12 Repo rate Reverse Repo rate

Since 2001, Sri Lanka has completed two tightening and two relaxing cycles in terms of policy interest rates The proactive measure of placing a ceiling on rupee credit expansion, considerably shortened the transmission lag.

23

During the year, foreign reserve accumulation has been prudent not too excessive nor too low
Reserves, which were used for intervention during the first half to face external challenges and to effect an orderly adjustment, were shored up by the end of the year Reserves improved to US$ 6.8 bn by end 2012 from US$ 6.0 bn by end 2011. This is equivalent to 4.4 months of imports.
9 8 7 6 5 4 3 2 1 0

Gross Official Reserves and Months of Imports

7 6 5 4 3 2 1 0 Months

US$ 6.8 bn 4.4 mths

US$ bn

The healthy reserve position was supported by the inflow of funds from foreign sources, which have been continuously encouraged in order to bridge the savings-investment gap 24

Jan-09 Feb-09 Mar-09 Apr-09 May-09 Jun-09 Jul-09 Aug-09 Sep-09 Oct-09 Nov-09 Dec-09 Jan-10 Feb-10 Mar-10 Apr-10 May-10 Jun-10 Jul-10 Aug-10 Sep-10 Oct-10 Nov-10 Dec-10 Jan-11 Feb-11 Mar-11 Apr-11 May-11 Jun-11 Jul-11 Aug-11 Sep-11 Oct-11 Nov-11 Dec-11 Jan-12 Feb-12 Mar-12 Apr-12 May-12 Jun-12 Jul-12 Aug-12 Sep-12 Oct-12 Nov-12 Dec-12 Gross Official Reserves (Left Axis) Months of Imports (Right Axis)

12

In particular, workers remittances increased significantly...

Workers remittances are estimated to be around US$ 6 bn in 2012, up by 16.8% from US$ 5.1 bn in 2011
As a percentage of GDP: 10% As a percentage of external current receipts: 30% Workers' Remittances
8.7% of GDP 7.9% of GDP 8.3% of GDP

Main reasons for the increase:

Incentives to encourage Sri Lankan migrants to open NRFC accounts Expansion in global branches of Sri Lankan commercial banks and ATM network mainly in the Middle East, Australia, France, Canada and Singapore Setting up of new exchange centers in Canada, Malaysia, Japan, Cyprus and Singapore Introduction of new web based products supported by the latest technology such as Peoples eRemittance Departures for foreign employment during the first half of 2012 stood at 139,092, which is an increase of 9.9% Increase of migrant workers of the professional category by 33%

US$ mn 7,000 6,000 5,000 4,000 3,000 2,000 1,000 0 2006

7.6% of GDP

10.1% of GDP

6,007

5,145

7.7% of GDP

7.2% of GDP

4,116

2,161

2,502

2,918

3,330

2007 2008 2009 2010 2011 2012 Est.

25

The high level of inflows on account of emerging services, also buttressed the current account
Foreign exchange inflows on account of emerging services such as export of software and Information Technology Enabled Services (ITES), helped to support the current account substantially Presently, there are over 400 IT and IT enabled entities with international recognition operating in Sri Lanka The Sri Lankan ICT/ BPO industry is among the top 5 export revenue earners for Sri Lanka, employing a workforce of 35,000, with exports amounting to over US$ 600 mn Sri Lankas ICT/BPO industry is set to achieve the target of reaching US$ 1 bn in exports by 2015 with an estimated workforce of over 80,000
US$ bn 4.0 3.5 3.0 2.5 2.0 1.5 1.0 0.5 0.0 2006 2007 2008 2009 2010 2011 2012 Est.

Inflows to the Services Account

26

13

In addition, other inflows to the capital and financial account were timely and significant
Net portfolio investments inflow (2012): US$ 305 mn. (In 2011, an outflow of US$ 171.5 mn was recorded) Project loans to the Government (excluding sovereign bond proceeds): US$ 1.6 bn (JanOct) Net inflows from sale of Government securities: Treasury Bills + Treasury Bonds (2012): US$ 843 mn Receipt of Government Grants: US$ 124 mn (JanOct) Foreign Borrowings by the Commercial Banks: US$ 973 mn (Jan-Nov) Sovereign Bond receipts: US$ 1 bn Corporate Sector inflows: US$ 307 mn (JanSep)
27

A robust and flexible exchange rate policy had been implemented, which has given consideration to all key aspects of the economy
Overall, the rupee depreciated against the US dollar by 10.4% in 2012, reflecting the increased demand for forex in the market, due mainly to oil imports However, since June 2012, the rupee appreciated by 5.3%, and is expected to stabilise over the medium-term
140 120 100 80 60 40 20 0

End-Month LKR/US$ Exchange Rate 1975-2012

LKR Movements against US$, GBP, and Euro

215 205 195 185 175 165 155 145 135 125 115 105 2-Jan-12 23-Jan-12 4-Dec-12 27-Mar-12 11-May-12 31-May-12 12-Nov-12 22-Aug-12 24-Dec-12 14-Feb-12 12-Sep-12 6-Mar-12 12-Jul-12 2-Aug-12 2-Oct-12 19-Apr-12 22-Oct-12 21-Jun-12

30 20 10 0 -10 -20 -30 -40 -50 1975 Dec 1976 Dec 1977 Dec 1978 Dec 1979 Dec 1980 Dec 1981 Dec 1982 Dec 1983 Dec 1984 Dec 1985 Dec 1986 Dec 1987 Dec 1988 Dec 1989 Dec 1990 Dec 1991 Dec 1992 Dec 1993 Dec 1994 Dec 1995 Dec 1996 Dec 1997 Dec 1998 Dec 1999 Dec 2000 Dec 2001 Dec 2002 Dec 2003 Dec 2004 Dec 2005 Dec 2006 Dec 2007 Dec 2008 Dec 2009 Dec 2010 Dec 2011 Dec 2012 Dec

Rs.

LKR/USD

LKR/GBP

LKR/EURO

1975 Dec 1976 Dec 1977 Dec 1978 Dec 1979 Dec 1980 Dec 1981 Dec 1982 Dec 1983 Dec 1984 Dec 1985 Dec 1986 Dec 1987 Dec 1988 Dec 1989 Dec 1990 Dec 1991 Dec 1992 Dec 1993 Dec 1994 Dec 1995 Dec 1996 Dec 1997 Dec 1998 Dec 1999 Dec 2000 Dec 2001 Dec 2002 Dec 2003 Dec 2004 Dec 2005 Dec 2006 Dec 2007 Dec 2008 Dec 2009 Dec 2010 Dec 2011 Dec 2012 Dec

Rupee depreciation against the US$ 1975-2012

28

14

Poverty alleviation and inclusive growth have been given high priority while socio-economic factors have been improving constantly and consistently
Poverty Headcount Ratio (% of Population)
40%

The dominance of the Western Province is diminishing and the contribution by other provinces to GDP is on the rise
Provincial Share of GDP

30%

28.8%

Province
22.7%

2000 49.6 9.4 9.4 2.2 4.5 10.4 3.9 3.9 6.7

2005 50.8 8.5 8.9 3.0 4.7 8.9 4.3 4.5 6.4

2011 44.4 9.8 11.1 3.7 5.7 10.0 4.6 4.5 6.2

Western Central
15.2%

20%

Southern Northern
8.9%

10%

Eastern North Western

0% 1995/96 2002 2006/07 2009/10

North Central Uva Sabaragamuwa

29

Prosperity as tracked by the Sri Lanka Prosperity Index (SLPI) has increased over the years...
Indicator Sri Lanka Prosperity Index Economy & Business Climate Well Being of the People SocioEconomic Infrastructure 2009 56.5 66.0 52.5 50.9 2010 58.2 67.4 54.4 52.8 2011 60.6 70.1 56.4 55.4 Growth
2010/11

4.1 4.0 3.6 4.9

Variables of the Sri Lanka Prosperity Index

1. 2. 3. 4. 5. 6. 7. 8. 9. 10. 11. 12. 13. 14. Per capita GDP Employment Rate Informal Sector Wages Percentage of Poor Households All Island/Provincial CPI Number of Industrial Enterprises per 1,000 Population (Density) Number of Bank Branches per 100,000 Population (Density) Government Hospital Beds per 1,000 Population Government Medical Officers per 100,000 Population Low Weight Births per 1,000 Live Births Schools per sq km Pupil Teacher Ratio Dropouts from Secondary Education (Secondary School Attainment) G.C.E O/L Pass Rate and Number of University Admissions per 100,000 Population

Improvements have taken place in all sub-indices. But the highest improvement has been in the Socio-Economic Infrastructure sub-index Prosperity has improved in every province during this period
Province-wise Performance of SLPI: 2009 - 2011
Western Sri Lanka Southern Central North Western S'gamuwa Northern North Central Eastern Uva 0 20 40 60 80 2010 2011 2009

15. Percentage of Schools with English Medium Classes 16. Number of Vehicles per 1,000 Population 17. Number of Supermarkets per 1 Million Population 18. Average number of Film-goers per Month as a Percentage of Population 19. Number of Persons Treated for Respiratory Diseases per 1,000 Population 20. Per Capita Mosquito Coil Usage 21. Per Capita Electricity Usage 22. Number of Telephone Connections per 1,000 Population 23. Road Density 24. Number of Reported crimes per 1,000 Population 25. Percentage of Schools with Safe Drinking Water Facilities 26. Percentage of Schools with Computer Facilities

30

15

At the same time, unemployment reached its historically lowest rate

Unemployment rate declined to 3.9% in first half of 2012 due to:
Continued employment generation due to expansion of economic activities Increased employment in the Industry sector, particularly construction Unemployment declining among more educated categories (GCE A/L and above) Total number of departures for foreign employment increased by 7.7% in the first half of 2012, over the same period of 2011
7 6 5 4 3 2 1 0 2007 2008 2009 2010 2011 2012 FH

These developments were in contrast to the experiences of other economies

Unemployment Rates % 2012 (Est)
25 20 15 10 5 0

Unemployment Rate %
6.0 5.4 5.8 4.9 4.2 3.9

Labour productivity also improved, but continued improvements are necessary

Overall labour productivity, measured by GDP per worker, has been improving Industry and Service sectors recorded growth in productivity However, labour productivity in the Agriculture sector remains low
Index Points

600

In Rs.'000 per person

500 400 300 200 100 2005 Agriculture 2006 Industry 2007 2008 Services 2009 2010 2011 Total labour productivity

Labour Productivity of Selected Economies (2002=100)

200 180 160 140 120 100 80 60 40 20 0
USA Germany Singapore UK Australia Japan Taiwan Sri Lanka

With declining unemployment and rising relative wages, improving labour productivity to spur economic growth has become increasingly important.

Source: U.S. Department of Labor, Bureau of Labor Statistics, CBSL Estimates

1990 1991 1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011

Australia Canada China Czech Republic France Germany Greece Indonesia Ireland Italy Japan Korea Malaysia New Zealand Pakistan Portugal Russia Singapore Spain Sri Lanka Sweden Switzerland United Kingdom United States

31

Movement of Labour Productivity

32

16

A serious commitment has been made by the Government towards sustainable fiscal consolidation
The overall fiscal deficit is estimated to be 6.2% of GDP in 2012, down from 6.9% of GDP in 2011, mainly due to expenditure rationalisation policies Recurrent expenditure declined, while public investment was maintained at a level to sustain the targeted growth momentum
Budget Deficit
2009 0 16 % of GDP -2 -4 % of GDP -6 -8 -8.0 -10 -12 0 -9.9 2009 2010 Recurrent 2011 Public Investment 2012 Rev Est -6.9 -6.2 4 12 8 6.8 6.4 6.2 2010 2011 2012 Est 20 18.2 16.7 15.4 14.7

Government Expenditure

5.8

33

As a direct result of the public investment, massive infrastructure projects have transformed the country
Road development projects The Southern Expressway Project - 126 km (Phase 1- Completed, Phase 2 completion 2013) The Colombo - Katunayake Expressway - 26 km (Completion 2013) The Colombo Outer Circular Highway Project 29 km (Phase 1- Completion 2013) Colombo North/East Highway Project (Feasibility study in progress) Kandy Badulla Alternate Highway Project 34 km (Feasibility study done) Power projects 900 MW Norochcholai Coal Power Plant (Phase 1 (300 MW) Commissioned, Phase 2 - completion
2014)

120 MW Uma Oya Hydro Power Project (Completion 2015) 500 MW Sampur Coal Power Project (Completion 2017) 20 MW Moragahakanda and Kaluganga Reservoir Project (In Progress) Port development projects The South Colombo Harbour Project (Phase 1 Completion 2013) The Hambantota Port Development Project (Phase 1 - Completed, Phase 2 completion 2015) The Oluwil Port Development Project (Completion 2013) The Kankasanthurei Port development Projects (In progress) Airport development projects Second International Airport at Mattala (Completion 2013) BIA Expansion Project (In progress) Domestic Airport Development Ampara, Koggala, China-Bay, Jaffna and Ratmalana Ongoing rural infrastructure development projects Gama Neguma, Maga Neguma, Small Irrigation projects and Kirigammana projects Lighting Sri Lanka (Target - 100% electrification by 2013) Several mega hotel projects, condominiums, shopping malls, development of Northern and Eastern provinces, and water supply projects 34

17

The 5-hub concept introduced in Mahinda Chintana, has been gaining ground while tourism has emerged as a key thrust industry
Aviation Hub Maritime Hub
Colombo Port Container mega hub Hambantota Port Free portservice, industrial and multi-purpose Galle Port Cruise shipping centre Trincomalee Port-related industries Oluvil Port Commercial and fisheries Kankasanthurei & Point Pedro Regional ports Second international airport at Mattala Modernisation of the Bandaranaike International Airport (BIA) and building of second runway at the BIA Development and upgrading of domestic airports Position Colombo as a regional logistics and services hub and as a hub for budget airlines

Tourism Hub
Arrivals to increase to 2.5mn by 2016 Earnings from Tourism to increase to US$ 2.8bn by 2016

Commercial Hub South Asian Economic Hub

Establish Sri Lanka as the foremost centre in the region in the provision of commercial services, International banking and international investments With growth of ports and tourism, Sri Lankas commercial sector will develop naturally

Energy Hub
Develop renewable energy sources New oil refinery at Hambantota Oil exploration and production 3 sea basins (offshore) have been identified (Mannar, Cauvery, Southern Waters) Develop oil trade-related ancilliary services including gas

Knowledge Hub
Target IT literacy and internet access for all Creation of knowledge-based jobs Commence degree programmes directly targeting foreign students Accredited foreign universities to set up university colleges in Sri Lanka

35

Tourist arrivals and earnings have been on target for 2012 & beyond
Tourist arrivals increased by over 17% to 1,003,000 During 2012, earnings from tourism is expected to have increased by 24% to US$ 1,029 mn. Targets for Tourism Sector by 2016, now seem more realistic: - Tourist arrivals: 2.5 mn - Foreign Direct Investment in Tourist related projects: US$ 3 bn - Tourism related employment: 500,000 persons - Foreign exchange earnings: US$ 3.5 bn Many accolades have been received from reputed media:
US$ mn 1,200 1,000 800 600 400 200 2009 2010 2011 2012 (Est)

Toursit Arrivals ('000)

Earnings from Tourism

140 120 100 80 60 40 20 0 Mar May Apr Nov Aug Feb Jun Sep Jan Jul Oct 2009 2010 2011 2012 Dec

Best place to visit in 2013 Lonely Planet Among six best of the world 2012 destinations National Geographic Traveler Magazine Ranked 3rd hottest new holiday destination to travel in 2012 Cond Nast Traveller Magazine Best destination to visit in 2013 British Airways

36

18

At the same time, Sri Lankas HDI Ranking has now reached the best level in South Asia, and is above the world average
HDI Value

Sri Lanka is the highest ranked in South Asia Sri Lanka is ranked 97 out of 187 countries Sri Lankas ranking in the Global Prosperity Index also increased with the ranking moving up to the 58th from the 63rd position

0.8 0.6 0.4 0.2 0

National Trends in HDI

Afghanistan India Pakistan

Bangladesh Nepal Sri Lanka

1980 1985 1990 1995 2000 2005 2006 2007 2008 2009 2010 2011

Sri Lanka compared to Average World HDI

0.70 0.65 HDI Value 0.60 0.55 0.50 1980 1990 2000 2005 Sri Lanka 2006 2007 2008 2009 World 2010 2011

37

Doing Business indicators and other international ratings have also recorded noteworthy improvements
Doing Business Index rose to 81st (for 2013) from 89th (for 2012) Sri Lanka is the highest ranking country in South Asia and is the only country in the region to improve its ranking for 2013 For the first time in 7 years, a South Asian country Sri Lanka, ranks among those improving the most
Sri Lankas position in World Indicators
2009 Index of Economic Freedom (Rank) Corruption Perception Index (Rank) Global Competitiveness Index (Rank) 111 97 79 2010 120 91 62 2011 107 86 52 2012 97 79 68 The 10 economies improving the most across 3 or more areas measured by Doing Business in 2011/12

38

19

Sovereign credit rating was maintained in a year where many countries ratings were downgraded
Fitch Ratings Standard & Poors Moodys

BBB+
negative

BBstable

B+
positive 2010

stable

B
negative

B+
stable

B+
positive

B+
stable

B1
stable 2010

B1
positive

B1
positive

2009

2011

2012

2009

2010

2011

2012

2011

2012

Sovereign Downgrades during 2012

Fitch Ratings South Africa BBB+ Stable to BBB+ Negative Spain A to BBB Cyprus BBB to BBSlovenia AA- to A Negative Belgium AA+ to AA Egypt BB- to B+ Greece CCC to C Japan AAA to AA+ Standard & Poors South Africa A to AItaly A to BBB+ France AAA to AA+ Negative Spain AA- to BBCyprus BBB to B Portugal BBB- to BB Negative Slovenia AA- to A Egypt B+ to B Argentina B to BMoodys South Africa A3 to Baa1 France Aaa to Aa1 Spain A3 to Baa3 Cyprus Ba1 to B3 Greece Ca to C Pakistan B3 to Caa1
39

The successful completion of the IMF - SBA was a significant milestone in the countrys economic history
By July 2012, the IMF completed eight reviews and released the entirety of the facility totalling US$ 2.55 bn, under the SBA

24 July 2009

6 November 2009

28 June 2010

24 September 2010

3 February 2011

4 April 2011

2 April 2012

20 July 2012

Approval

First Review

Second & Third Review

Fourth Review

Fifth Review

Sixth Review

Seventh Review

Eighth Review

First Tranche

Second Tranche

Third & Fourth Tranche

Fifth Tranche

Sixth Tranche

Seventh Tranche

Eighth Tranche

Ninth Tranche

US$ 321 mn

US$ 331 mn

US$ 408 mn

US$ 213 mn

US$ 217 mn

US$ 219 mn

US$ 426 mn

US$ 414 mn

Discussions will take place this year regarding the way forward in the countrys future engagements with the IMF

40

20

The growing confidence of overseas investors was evident from the performance of the fifth sovereign bond, which set a new benchmark
Increased Investor Base
600 10.5 400 200 0 6.8 1.6 135 2007 2009 # Investors (LHS) 6.5 7.5 8 4 0 2010 2011 2012 Orderbook (RHS) (USD bn) 12 1000 750 500 260 310 315 425 250 0 2007 2009 2010 2011 2012 Rate Amount (USD mn) 3 0

Progressive Reduction in Cost

8.25 9 7.4 6.25 6.25 5.875 6

10 8 Percent 6 4 2 0 Feb-10 Apr-10

Strong Secondary Market

20 15 Per cent 10 5 0 Aug-12 Dec-12 Jun-12 Oct-12

10-Year Sovereign Bond Yields

Portugal Spain Philippines Italy US Sri Lanka Ireland Brazil

SL 7.40% due 2015 SL 6.25% due 2021

SL 6.25% due 2020 SL 5.875% due 2022

29-Dec-11

31-Mar-12

31-May-12

41

Although somewhat slow, gradual adjustments took place in the two key SOEs, CPC and CEB
Ceylon Petroleum Corporation (CPC)
Domestic Petroleum prices were revised substantially in February 2012 and again in December 2012. These measures have served to reduce the losses of CPC, but still, significant losses are incurred. Discussions are being held to extend suppliers credit beyond 30 days, thereby avoiding/delaying the necessity to obtain foreign exchange loans from banks at market rates Arrangements are being made to acquire crude oil and bulk petroleum through bilateral arrangements with oil producing countries. As a result, spot tenders and price hikes would be avoided. Plans are being made to expand the existing refinery. Measures are being taken to improve the product mix yield in the refinery, i.e., conversion of crude oil to yield greater output of high-end products such as diesel and petrol.

Ceylon Electricity Board (CEB)

The Fuel Adjustment Charge (FAC) was introduced to recover fuel usage cost due to drought conditions. However, electricity is still being provided at subsidised prices and significant losses are incurred. Action is continuously being taken to change the power generation mix in favour of less costly sources, such as hydro, wind and coal. Work on such power plants is already in progress. Urgent steps need to be taken to ensure that these two institutions reach at least break-even level by end 2013, in order to ensure their viability and to eliminate any imbalances being created in the banking sector

42

30-Nov-12

31-Aug-12

31-Dec-12

29-Jan-12

29-Feb-12

30-Sep-12

30-Jun-12

31-Jul-12

30-Apr-12

31-Oct-12

Feb-11 Apr-11

Dec-09

Dec-10

Aug-10

Aug-11

Dec-11

Feb-12 Apr-12

Jun-10

Oct-09

Oct-10

Jun-11

Oct-11

21

Improvements in other SOEs have been aimed at minimising losses and transforming loss making ventures into profit making institutions
National Water Supply and Drainage Board Water tariffs were revised upwards to better reflect costs Sri Lanka Railways Reduced recurrent expenditure using better management techniques. Deployed 30 new power sets Northern railway line was completed up to Omanthai Improvements to the southern railway line to enable high speed train services Southern railway line extension up to Beliatta is in progress Sri Lanka Transport Board Procured 291 new buses and repaired 1,024 buses 13 luxury and 11 semi-luxury buses were deployed during 2012 Lanka Phosphate Limited Increased dividend payments to the Treasury in 2011/12. New machinery worth Rs.56mn installed Manufacturing capacity to be doubled SriLankan Airlines Added more destinations and increased frequencies to existing destinations Increased the airlines fleet to benefit from tourism boom

It is vital that these improvements are effected at a faster pace, in order to reduce/eliminate their dependence on Treasury funds, at least by the end of 2014
43

The Public Debt has been managed prudently, and the Debt to GDP ratio has been improving gradually
The debt to GDP ratio is estimated to be 81% in 2012, marginally higher than 78.5% of GDP in 2011.
This is mainly due to the one-off increase of about Rs.278 bn in the public debt on account of the depreciation of the rupee
Outstanding Government Debt (as a % of GDP) Sri Lanka
104 100 96 92 88 84 80 76 72 102.3 102.3

Selected Countries Debt to GDP ratios - 2011

250 200 150 100 50 0 Spain Singapore Germany UK 88.7 UK Greece Japan Italy Sri Lanka France Portugal Ireland USA 107.2 USA 86.0 80.6 165.4 106.5 120.1 107.8 107.6 69.1 78.5 81.8 102.9 229.6

Selected Countries Debt to GDP ratio estimates for 2012

250 200 170.7 117.7 126.3 90.0 83.0 119.1 106.2 90.7 236.6

Per cent

90.6

87.9 85 81.4

150 86.2 81.9 78.5 81 100 50 0 Germany

81

Singapore

Greece

Japan

Spain

Italy

2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 (est)

Sri Lanka

France

Ireland

Portugal

44

22

The risk indicators of Sri Lankan public debt have also improved, at a time where global risk has been rising
UN-ESCAP Definition Levels Indicator Less Indebted <30% Moderately Indebted >30% and <50% Highly Indebted >50% Sri Lanka 2012

Disbursed External Debt Outstanding/Gross National Income Disbursed External Debt Outstanding/Exports of Goods and Non Factor Services Total External Debt Service Payments/Exports of Goods and Non-Factor Services External Interest Payments/Exports of Goods and Non-Factor Services Net Present Value of External Debt/Gross National Income Net Present Value of External Debt/Exports of Goods and Non- Factor Services * Data for 2011

37.0%

<165%

>165% and <275%

>275%

112.6%

<18%

>18% and <30%

>30%

10.7%

<12%

>12% and <20%

>20%

3.7%

<48%

>48% and <80%

>80%

40.0% *

<132%

>132% and <220%

>220%

130.0% *

Source: Manual on Effective Debt Management, UN-ESCAP, 2006.

45

However, the cost of domestic debt portfolio increased for most part of the year, but started moderating towards the latter part of the year
25%

Primary Market Yield Curve

20%

15%

Due to the tight monetary policy conducted by the Central Bank and increased investor preference for short term securities, the overall average interest rate of Treasury bills and Treasury bonds increased during the first four months of 2012. However this trend reversed during the latter part of the year

10% End Dec 08 5% End Dec 09 End Dec 10 End Dec 11 0% 0 1 2 3 4 5 6 7 End Dec 12 8 9 10

Maturity Period (Years)

46

23

During the year, the interest cost as a percentage of GDP decreased marginally, while the average time to maturity of domestic currency debt improved
Interest Cost as a % of GDP
500 8% Years 7 6 6.29% 5.45% 6% 5 4 4.82% 4% 2 200 1 2% 100 0 2008 T-bills 0 2005 2006 2007 2008 2009 2010 2011 2012 0% 2009 T-bonds 2010 2011 R-Loans 2012 Overall 3 2.17 2.25 2.35 2.10 3.32

Average Time to Maturity

6.42% 400 4.90% 300 Rs. bn 5.13% 5.10%

5.43%

Interest Cost (Rs bn)

As a % of GDP

Total interest cost as a percentage of GDP reduced marginally to 5.43% despite the depreciation of the Exchange Rate and the Interest Rate fluctuations throughout the year.

47

Despite challenges and shocks to the economy, Sri Lankas financial system maintained stability, even while expanding
Stability and strength of the banking sector was maintained Performance of financial institutions improved Regulations were strengthened and streamlined Efficiency of the Payment and Settlements system increased Safety net mechanisms and consumer protection were further strengthen and developed
Expansion of Banking Outlets

Item
Bank Branches Other Banking Outlets ATMs

2008 1,782 3,646 1,676

2011
2,130 4,054 2,237

2012
(Provisional)

2,193 4,103 2,331

48

24

The Banking sector was responsive to the needs of the economy, and thereby helped achieve a more rapid and sustainable economic growth
The Banking sector has become increasingly competitive and strong during the recent years
Assets Growth
6 5 Amount, Rs tn 4 3 2 1 0 2.7 3.0 3.6 4.3 4.6 4.9 5.0
2008 2009 2010 2011 Sep'12 Nov'12 Mar'12

Loans Growth
30 3.5 3.0 Amount, Rs tn Growth, % 2.5 2.0 1.5 1.0 0.5 0.0 25 20 15 10 5 0 40 35 29.2 30 23.7 23.3 25 20 15 6.6 10 5 (2.3) 0 1.6 1.6 2.0 2.6 2.8 3.0 3.1 -5
2008 2009 2010 2011 Sep'12 Nov'12 Mar'12

Deposits Growth
4.0 3.5 3.0 Amount, Rs tn Growth, % 2.5 2.0 1.5 1.0 0.5 0.0 1.9 2.2 2.6 3.1 3.2 3.5 3.5
2008 2009 2010 2011 Sep'12 Mar'12 Nov'12

24.4 17.8 11.7 7.7 19.8

22.5

36.3 31.7

21.6 18.8 15.9 18.8 19.3

25 18.2 20 15 Growth, %

21.2

7.9

10 5 0

Assets

Assets Growth

Loans

Loans Growth

Deposits

Deposits Growth

49

Banking sector stability indicators improved, further consolidating the progress

Capital Adequacy Ratio
18 16 14 12 10 8 6 4 2 0
16.1 16.2 16.0 12.6 12.8 10.4 10.5 12.3 11.9 11.4 13.4 13.3 14.1 14.5 15.0

Sep-12

Capital Adequacy Ratio (CAR) of banks was maintained at well over the minimum level of 10% The Basel II Capital Adequacy Standards continued to be implemented and monitored. Consultation paper on implementation of ICAAP and SRP under Pillar 2 of Basel II issued.
Liquidity improved

Per cent

1998

1999

2000

2001

2002

2003

2004

2005

2006

2007

2008

2009

2010

Profitability maintained
5 4 Ratio, % 3 2 1 1.1 0 2008 2009 2010 2011 Mar'12 Sep'12 Nov'12 Return on Equity Interest Margin Return on Assets 1.0 0 1.8 1.7 1.8 1.7 1.7 13.4 11.8 4.4 4.6 4.6 22.0 4.2 19.7 4.1 21.1 4.1 20.0 25 4.1 20 19.6 Ratio, % 15 10 5

2011

80 70 Ratio, % 60 50 40 30 20

70.0 60.9 63.9

70.2

70.2

71.2

71.2

39.2 31.3

36.6

32.4

31.6

30.9

31.3

2008

2009

2010

2011

Mar'12 Sep'12 Nov'12 SLAR -DBU

Credit to Deposits & Borrowings

50

25

During the year, several banks successfully accessed international debt capital following the advice of the Central Bank to tap the international markets
Banks adopted an internationalised approach and used/ leveraged their balance sheets more efficiently to meet the resource gap Several banks secured a total US$ 973 mn, of which 70% were long term borrowings
US$ 1,100 mn - Approved US$ 973 mn Received (88%)

Long Term Tenors 70% Five to Ten Years

51

Continuous supervision and quick guidance helped to ensure a stable, streamlined financial system
Speedy approval granted to open bank outlets islandwide Reviewed current classification of banking outlets to streamline and rationalise approval procedure
Safety net mechanism and consumer protection was strengthened
The Mandatory Deposit Insurance Scheme continued to grow and reached around Rs.8.9 bn by end 2012 Obligations of customers and banks were published in the form of a Customer Charter Continuous monitoring took place to ensure adherence to Customer Charter

52

26

The massive campaign against Prohibited schemes continued during the year
Newspaper advertisements regularly listed institutions licensed to accept deposits Extensive TV and Radio ad campaigns targeted Northern and Eastern provinces especially, in combating prohibited schemes A framework was put in place to take action against prohibited schemes, in a systematic manner

53

A number of financial risk assessment techniques were developed to assist in the system stability analyses
Test/Indicator Sensitivity Stress Testing What it does Gauges resilience to shocks relating to credit risk, market risk, liquidity risk and exchange risk (Quarterly) Assesses resilience of the financial system to extreme but plausible macroeconomic shocks (Quarterly) Test is based on Information of individual banks and banking industry, relevant to each risk category Selected macro-economic variables and its impact on the asset quality of the banking sector

Macro Stress Testing

Banking Soundness Index Assesses the soundness (financial stability) Selected financial soundness indicators (capital, (BSI) of the banking sector (Quarterly) asset quality, profitability, liquidity, sensitivity to market risk) Financial Market Stability Assesses the stability of the financial Indicator (FMSI) markets over a period of time for any buildup of risks (Monthly) Macro-economic Stability Assesses macro-economic stability Indicator (MESI) (Quarterly) Analysis of 10 variables associated with money and bond market, forex market and equity market Analysis of key indicators of the real, external, fiscal and monetary sectors of the domestic economy and global developments

Financial System Stability Quantifies overall financial system stability Analysis of 3 major indices, BSI, FMSI and MESI Indicator (FSSI) in Sri Lanka through a composite indicator (Quarterly)

54

27

Non-banking sector assets & deposits improved

Total Assets - Amount & Growth
Rs.bn 600 500 22.7 400 300 200 100 30-Sep-08 30-Sep-09 30-Sep-10 30-Sep-11 30-Sep-12 Amount (Rs.bn) Growth Rate (%) 1.9 21.8 29.6 24.0 (%) 35.0 30.0 25.0 20.0 15.0 10.0 5.0 -

Loans and Advances - Amount & Growth

Rs.bn 500 450 400 350 300 250 200 150 100 50 48.3 (%) 60.0 50.0 40.0 25.3 18.0 26.6 30.0 20.0 10.0 (2.8) (10.0) 30-Sep-08 30-Sep-09 30-Sep-10 30-Sep-11 30-Sep-12 Amount (Rs.bn) Growth Rate (%)

Deposits were the major source of funding, representing 41% of the total liabilities Capital Funds increased by 24% to Rs. 84 bn Loans and advances accounted for 80% of assets, of which, finance leasing and hire purchases accounted for around 72% Asset quality of the sector improved, with NPA ratio reducing from 5.5% in 2011 to 5.0% in 2012 Branch network increased by 129 to 833 during the first nine months of 2012

Non Performing Advances - Amount & Ratios

Rs.bn 25 20 15 10 5 30-Sep-08 30-Sep-09 30-Sep-10 30-Sep-11 30-Sep-12 Gross NPA (Rs.bn) Net NPA Ratio (%) Gross NPA Ratio (%) 5.9 4.8 2.9 4.8 9.2 9.7 (%) 12.0 10.0 8.0 5.5 1.9 5.0 1.6 6.0 4.0 2.0 -

55

while proactive and timely supervisory policy measures produced the desired outcomes
New Directions Issued to Finance Institutions
Upper limit interest rates for LFCs revised Minimum requirements for information systems security Panel of External Auditors selected and guidelines Gradual increase of minimum core capital to be maintained by SLCs from Rs.100 mn by Dec. 2012 to Rs.300 mn by Jan. 2016 Core capital as yardstick for gearing ratio Fitness and Propriety of Directors Changes to borrowing definitions

Supervisory Action Taken

Internal Rating system developed Early Warning Systems developed

Combating Unauthorised Finance Institutions

Regularised unauthorised institutions and initiated action against others 27 Public awareness programs, 14 Audio programmes, 33,000 Brochures and 1,550 Posters Established procedure manual for investigation of unauthorised firms

Initiating Regulatory Mechanism for Microfinance Sector

Finalising legislation to consolidate the microfinance sector

Revival of Distressed Companies

7 Distressed finance companies affected by liquidity crisis were being restructured

56

28

The Payments & Settlements System benefitted by several innovations in 2012

Issued licences to 3 new service providers to engage in debit card business Issued a licence to a mobile telecommunication network operator to operate an e-money scheme Facilitated the establishment of the Common Card and Payment Switch (CCAPS) by LankaClear (Pvt) Ltd., to provide a national level platform for clearing and settlement of electronic payments Commenced self assessment of the LankaSettle System against the new core principles of the Committee on Payment and Settlement Systems (CPSS) Conducted public awareness programmes to increase awareness on payment and settlement systems
Performance of the Payments System 2012 System availability Average No. of RTGS Transactions per day (High value payments) Average No. of Retail Payments per day 99.8%

1,140

387,050

57

The Employees Provident Fund grew by 13% to Rs.1.15 trillion in 2012

Rs.301 bn was invested in government securities during 2012 to benefit from high interest rates in the government securities market. The share portfolio yielded Rs.2,774 mn as realised income (dividends and capital gains) during the year Long term share portfolio was maintained in order to benefit from the expected future upturn in the equity markets Interest paid on member balances for 2011: 11.5% pa.
To enhance the efficiency of member service:
EPF Act No 15 of 1958 was amended to compel employers to send member contributions and payment details electronically. Commercial banks were appointed as collecting agents of member contributions EPF Website was connected with Lanka Gate E-governance service to provide wider access for members New members were registered under a unique identification number to enable linking with their previous account numbers. 2011 Type Govt. Securities Equities Corporate Debentures & Other Reverse Repo Fixed Assets & Net Current Assets
Value (Rs.bn) Share %

2012
Value (Rs.bn) Share %

898 78 9 3 32

88.0 7.7 0.9 0.3 3.1

1,036 68 9 2 37

89.9 5.9 0.8 0.2 3.2

Total

1,020

100 1,152

100

58

29

Foreign Reserves management returns showed remarkable results in 2010, 2011 and 2012 amidst challenges
Absolute Returns 1988 - 2012
500 400 US$ mn 300 5 200 100 0 1988 1990 1992 1994 1996 1998 2000 2002 2004 2006 2008 2010 2012 4 3 2 7 6

Returns earned between 2010 - 2012 amounted to almost US$ 1.0 bn. Returns during the past 3 years have been the highest ever in history
Returns made in 2011 (%) CBSL

Year

Absolute Return (US$ mn)

CBSL Return %

Benchmark return % (2 Yr Govt Treasuries Average Rate)

1 0 Source: Respective Central Bank Annual Reports

2010 2011 2012

341 430 220

6.2% 6.6% 4.0%

0.7% 0.4% 0.3%

CBSL out-performed most of the leading central banks in reserve management during 2011

59

Currency management improved further in 2012

Measures taken to inculcate good habits of handling currency notes and coins through public awareness programmes Implemented the Clean Note Policy, in association with licensed banks and general public Developed close relationship with law enforcement authorities to educate the general public on security features of currency notes Issued instructions to licensed banks and finance companies to have counterfeit detectable counting/sorting machines Effected continuous improvements in human capital, with regular and special training programmes, seminars, workshops and discussions conducted, locally and internationally Issued two commemorative coins to mark 100 years of Scouting in Sri Lanka and the 60th anniversary of Sri Lanka-Japan diplomatic relations
60

30

Profit transfers increased several fold in the past few years, greatly assisting the revenue streams of the Government
During the period 2006-2012, the Central Bank has been able to appropriate a sum of Rs.112 billion to the Government from the surpluses the Bank generated, mainly from its international operations
Profit Transfers by the Central Bank to the Government
35 30 25 Rs. bn 20 15 10 5 0 2012 P 1977 1978 1979 1980 1981 1982 1983 1984 1985 1986 1987 1988 1989 1990 1991 1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 0 0 0 0 1.5 1.6 1.5 1.8 1.7 1.6 2 0.5 0.5 0.1 1 0 4 2.7 3 3.2 1 1.4 1.7 1.5 15 11 7.5 3.5 5.6 0 8 4 0 25 27 33

From 1976-2005 period of 30 years, the profit transfers amounted to about Rs.60 billion. From 1950-1975 period, the total profit transfers amounted to about Rs.30 million.

61

The Central Bank has been in constant touch with its stakeholders in 2012
.

Web Communication Average visitors in 2012 212,929 per day

SMS Alerts: Our new initiative, since October 15th

62

31

When taken on an overall basis, current macro fundamentals have reached reasonably benign levels, and have been moving in the right direction
Unit
Real GDP Growth GDP at 2002 Prices GDP Per Capita GDP in US$ Unemployment Inflation (Average) Trade Balance Tourist Arrivals Remittances FDI Inflows International Reserves International Reserves Exchange Rate Budget Deficit Public Debt Broad Money Growth (M2b) Private Sector Credit Growth Stock Market Capitalisation % Rs. bn US$ mn US$ % % % of GDP 000 US$ mn US$ mn US$ mn Months of Imports Rs./US$ % of GDP % of GDP % % Rs. bn

2000
6.0 1,598 16,596 899 7.6 6.2 -10.8 400 1,160 175 2,131 3.5 80.06 9.5 96.9 12.9 11.8 88.8

2006
7.7 2,091 28,267 1,421 6.5 10.0 -11.9 560 2,161 604 4,005 4.7 107.71 7.0 87.9 17.8 24.0 834.8

2011
8.3 2,864 59,175 2,836 4.2 6.7 -16.4 856 5,145 1,066 7,989 4.7 113.90 6.9 78.5 19.1 34.5 2,213.9

2012 (Est/Proj)

6.5 3,049 59,253 2,922 4.0 7.6 -15.1 1,003 6,007 1,000 7,800 5.0 127.16 6.2 81 16.2 18.6 2,167.6

63

In that scenario, per capita incomes have been improving consistently, as envisaged
2012 2011 2010 2009 $2,400 2003 $2,057 $981 $2,836 $2,922

64

32

The stage is now set for sustained progress towards a US$ 100 billion economy and a US$ 4,000+ per capita income

65

Towards such an outcome, the Medium Term Macroeconomic Framework will need to be carefully fashioned, while providing for the expected acceleration of economic activity
Indicator
Real Sector Real GDP Growth GDP Deflator Total Investment External Sector Trade Balance Current Account Balance Overall Balance Fiscal Sector Current Account Balance Overall Budget Deficit Government Debt Monetary Sector Broad Money Growth (M
2b)

Unit

2012
(Est)

Projections 2013
7.5 7.0 31.0

2014
8.0 6.0 32.0

2015
8.3 5.0 32.5

% % % of GDP

6.5 8.5 30.3

% of GDP % of GDP US$ mn

-15.1 -5.5 100

-14.4 -4.7 510

-13.3 -3.3 795

-12.7 -2.0 1,925

% of GDP % of GDP % of GDP

-0.8 -6.2 81

-0.1 -5.8 78

0.8 -5.2 75

1.4 -4.7 71

16.2

15.0

15.0

14.0

The projections for 2013 are based on the following assumptions Global economy expected to grow by around 3.3% Commodity prices expected to remain reasonably stable Advanced economies expected to maintain accommodative policies Domestic weather conditions expected to be favourable

66

33

Ensuring that inflation stays on course to be at midsingle digits over the next 5 years will be a priority
The Central Bank will continue to focus on keeping demand driven inflationary pressures in check, and maintain inflation, particularly core inflation, at the desired mid single digit levels
Year-on-Year Headline and Core Inflation
12 10 Per cent 8 6 4 2 0 Sep-09 Sep-10 Sep-11 Dec-08 Dec-09 Dec-10 Dec-11 Sep-12 Mar-09 Mar-10 Mar-11 Mar-12 Dec-12 Jun-09 Jun-10 Jun-11 Jun-12

Headline Inflation (y-o-y)

Core Inflation (y-o-y)

The achievement of maintaining single digit inflation for 47 months in spite of severe supply side shocks would help contain adverse inflation expectations and inflation-related wage spirals.
67

The Central Bank will also focus on two key factors in order to maintain macro-economic stability
With inflation stabilising, sustainable economic growth will be a key outcome, especially under the current global economic conditions Employment, which is at a historic high, will be considered a continuous priority, while due attention will be paid, to deal with any incidence of wage driven inflation
Expected Real GDP Growth 2013-2016
10 8.0 8.3 8.5 20 20

Unemployment Rate
25

Unemployment Rate - World

25
France Germany Greece Iceland

7.5

Per cent

Per cent

Per cent

15

15

Ireland Italy

10

10
Japan Portugal Spain

4 5 2 0 1990 2000 2004 2005 2006 2007 2008 2009 2010 2011 1H 2012 0 2013 2014 2015 2016 0 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 5

United Kingdom United States

68

34

In the determination of the Exchange Rate (ER), market based flexibility will be maintained
The ER will be allowed to reflect market conditions. The Central Bank intervention in directly supplying and absorbing foreign exchange, will be limited to reducing excessive fluctuations and maintaining external reserves at desired levels.
NOP limits of LCBs will be increased with effect from 2nd January 2013 to give LCBs more flexibility in managing their foreign exchange transactions. Limits on forward market transactions will be relaxed with effect from 2nd January 2013. Selected Derivative products will be allowed to be developed within broad guidelines that will be issued during 2013.
69

The Central Banks monetary policy will be conducted within the current framework of monetary targeting
This framework has provided greater transparency and flexibility in the conduct of monetary policy, particularly in difficult times.
The imposition of monetary targets, such as the credit ceiling acted as a tool to supplement the traditional transmission mechanism, and served to control the intermediate target of broad money directly.
In the global economy too, with key policy rates reaching almost zero, central banks are increasingly using monetary and liquidity aggregates to communicate monetary policy signals. Recent comments by Governor-elect, Bank of England regarding nominal income targeting, confirms the usefulness of unconventional strategies.

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The policy rate corridor will continue to guide short term interest rates
Considering short term interest rates as a target variable could support the economy to move towards explicit inflation targeting in future Stability of the benchmark yield curve will be promoted, which would help the effectiveness of monetary policy transmission Greater focus will be on real interest rates in order to promote domestic savings while encouraging productive activity

Operationally, the following changes will be considered during the year

Lengthening the current one week reserve maintenance period to two weeks, thereby allowing greater flexibility for banks in managing their day-to-day liquidity Conducting regular term auctions to address structural liquidity Enhancing operational capabilities in order to be able to fine-tune operations to manage day-to-day liquidity in a more effective manner
71

The Central Banks Communication policy will act as a key instrument in monetary policy
Market expectations have become an important component of monetary policy transmission
An advance release calendar for Monetary Policy announcements will be issued Press conferences and interviews will be held regularly Training courses for journalists will continue Awareness programmes will continue Web presence will be enhanced through the official website, social media and mobile networking

The Central Banks future communications will also reflect the economys structural shift towards a wider range of foreign exchange earning activities
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36

At the same time, the Central Bank will facilitate other key activities that have a direct impact on the ER, since a flexible, but stable ER will be considered a key stabilisation factor
FDI, portfolio investments and bond market investments will be supported Raising debt capital by banks from foreign sources will be encouraged Foreign borrowings by the private sector will be made more convenient Private and Workers remittances will be continuously encouraged Import substitution measures, particularly in food, will be supported Fuel and electricity generation that involve large amounts of imported inputs, will be supported to become more efficient and less reliant on such inputs Large scale foreign exchange earning activities will be encouraged: e.g. tourism, knowledge based activities, global commercial activities, education, health, port and aviation related activities, etc. Prudent sovereign debt management will be pursued, to provide a continuously improving international benchmark that will assist private sector funding activities as well Productivity level enhancements will be actively promoted
73

The trade & services gap will also be managed proactively, so as to not lead to excessive pressure on the BOP and the Exchange Rate
Increased inflows from tourism, service exports and workers remittances will be keenly supported to mitigate the impact of the trade deficit Realisation of expected capital flows will result in a favourable outcome in the BOP.
External Current Account Balance (% of GDP)
10 5 0 -5 -10 Per cent -15 -20 -25 -30 -35 -40 2012 (E) 2013 (P) 2014 (P) 2015 (P) 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 Bangladesh India Maldives Nepal Pakistan Sri Lanka

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37

In addition, greater emphasis will be placed on developing alternative non-inflationary sources of financing
The corporate bond market and the equity market will be encouraged to play a greater role in supporting the financing needs of the economy, thereby reducing reliance on short-term bank credit. Direct financing from external sources will be encouraged
Expectations for the Stock Market
80 70 60 US$ bn 50 40 30 20 10 0 2012 2013 2014 2015 2016 (Target) US$ bn 12 10 8 6 4 2 0 2012 2013 2014 2015 2016 (Target)

Expectations for the Corporate Debt Securities Market

Stock Market Capitalisation

Size of Corporate Debt Securities Market

75

Steps will be taken to bridge the high savingsinvestment gap through medium to long-term measures, for the economy to realise its true potential
Long-term domestic savings will be encouraged through positive real interest rates and promotion of pension funds and life insurance Capital market development will be promoted to support investments, local and foreign Foreign investment will be encouraged by maintaining a conducive policy environment and creating an enabling environment
Domestic Savings-Investment Gap
40 30 20 As a % of GDP 10 0 -10 -20 -30 1980 1982 1984 1986 1988 1990 1992 1994 1996 1998 2000 2002 2004 2006 2008 2010

Investment

Domestic Savings

Savings-Investment Gap

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Further strengthening financial institutions and deepening financial markets will be key strategies for 2013 and beyond
Approval from the Controller of Exchange has been dispensed with, for
Corporate entities to borrow up to US$ 10 mn per annum over the next 3 years LCBs to borrow from overseas up to US$ 50 mn each year over the next 3 years All residents who provide services to non-residents to be able to maintain Foreign Exchange Earners Accounts in currencies of their choice in LCBs Resident Sri Lankans as well as expatriates to be able to transfer foreign savings up to US$ 5 mn into Sri Lanka

Banks will be encouraged to access stable wholesale funding sources without relying only on short-term small scale customer deposits. National Development Bank and DFCC Bank will be allowed to raise US$ 250 mn each, with up to 10-year tenor to fund SMEs, plantations, construction and manufacturing industries. Banks will be expected to consider raising a significant part of their Tier I and Tier II capital, from foreign sources, by building strong Balance Sheets.

77

Several existing Exchange Control policies will be relaxed in 2013 and beyond
Time restrictions on forward foreign exchange transactions will be removed with effect from 2nd January 2013 A new investment account for non-residents amalgamating several types of investment accounts currently maintained at LCBs will be introduced with effect from 2nd January 2013 A new Inward Remittances Distribution Account, which can be used as a clearing account to disburse earnings of Sri Lankans providing services abroad, will be introduced with effect from 2nd January 2013 Foreign borrowings by companies for investment and business purposes to be allowed under the External Commercial Borrowing Scheme The current limit on overseas investments by residents will be increased Criteria for permitting selected non-banking entities to engage in foreign currency deposit business will be introduced Inward remittances through mobile phones will be facilitated A mechanism to change foreign currency through ATMs of LCBs will be introduced Fund transfers involving shipping companies, port operations and harbour services will be facilitated

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The Governments announced commitment to continued fiscal consolidation would greatly facilitate the effective conduct of monetary policy
This commitment is particularly welcome when many other countries are grappling with fiscal deterioration.
(%) 10 8 5 7.0% 3 0 2006-08 Average 2009 2010 2011 2012E 2013P 2014P 9.9% 8.0% 6.9% 6.2% 5.8% 5.2%

General Government Fiscal Balance to GDP Ratio in Selected Economies

8 6 4 2 0 2006 2012

Fiscal deficit (as a % of GDP)

Per cent

-2 -4 -6 -8 -10 -12

79

Since debt dynamics play a vital role in the maintenance of both price and financial system stability, developments in public debt will be monitored carefully
Transparency in public debt management will be enhanced Advanced risk management systems for public debt management will be introduced The continuous enhancement of sovereign credit rating will be pursued
Indicator
Debt/GDP ratio (%) Average Time to Maturity of Domestic Debt (years) Ratio of Short-term Domestic Debt to Total Domestic Debt (%) Share of Foreign Currency Debt to Total Debt (%)
100 80 60 40 20 0 2012 2013 2014 2015 2016 2017

Projection of Outstanding Public Debt (as a % of GDP)

81 78 75

71

68

65

2011 78.5 2.4 25 44

2012 (Est) 81 3.2 24 47

Revised Annual Target 2013 2014 2015 78 3.5 23 42 75 3.7 22 40 71 4.0 21 38

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Many improvements to the G-SEC market are planned/contemplated for 2013 and beyond
Efficiency of the primary auction system will be further improved
Half-yearly Treasury bond Calendar will be issued to the market Competition at primary auctions will be increased through greater participation of institutional investors Complete underwriting of issuances will be ensured by putting in place, an appropriate mechanism, including liquidity support for primary dealers An e-trading platform will be established and reporting of all G-SEC transactions will be made mandatory A guaranteed central clearing arrangement on net-settlement basis (rupee leg and security leg) will be established to eliminate counterparty credit risk while enhancing the efficiency of intraday liquidity of participants The trading platform to require mandatory two-way quotes Covered short selling will be introduced Information asymmetry will be eliminated, thereby narrowing spreads Appropriate products for a derivative market which will help participants to enhance their return while hedging their risk exposures in the cash market, will be introduced once the cash market is developed

Secondary market will be broadened and deepened while improving transparency

81

In the long-run, productivity growth will be a vital instrument of improving competitiveness and living standards...
The continued decline in unemployment in Sri Lanka in recent years, compels re-thinking of the future employment strategies. In this context, labour force concentration will need to be given careful attention

Although the share of Agriculture in the GDP has declined over time, the share of employees in the sector has not reduced proportionately Despite inherent limitations for expansion, special attention will need to be paid to developing productivity in the Agriculture sector, as it is a vital sector of the economy Share of Key Sectors in GDP and Concerted efforts by relevant authorities will need Labour Force to be continued in order to improve agricultural Share of GDP 12 output and reduce price volatility:
Effective information dissemination, Introduction of a crop calendar, Facilitation and enhancement of storage facilities, Strengthening of domestic forward and futures markets for agricultural produce
30 43 57 27 Share of Labour Force

31

Agriculture

Industry

Services

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41

Closer integration of the key sectors will also improve productivity

One of the key issues with Sri Lankas external trade has been the export of primary products where domestic value addition is low Given Sri Lankas widespread agricultural base, forward linking into Agro based Industries would be a natural next step for workers in Agriculture
Improvements in productivity in the Long-Term will also provide an important positive supply side shock Very often, negative shocks to the economy from various sources are discussed However, improved productivity in all three sectors of the economy would help bring down inflation and sustain price stability in the long run Sri Lanka would then be able to remain a competitive supplier in the global economy

A stronger domestic production base would lead to a more sustainable economic growth

83

Productivity improvements will need to be supported by evolving physical and socio-economic infrastructure
Continue improving: - Road and rail networks for connectivity - Ports and Airports to facilitate transportation - Energy, telecommunication, etc. to facilitate economic activity - Education and health services to suit the countrys requirements - Use of technology Introduce socio-economic practices that are vital in a society that is gradually improving: Have child-care facilities at work places, especially to increase female labour force participation Introduce flexible work hours/ strategies Absorb differently-abled citizens into the workforce The Central Bank is proud to welcome nine new differently-abled graduates to its workforce from 1st January 2013

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Since oil imports account for over 25% of current imports, moving towards sustainable and renewable energy is an important factor in the future progress of the economy
There is renewed focus on increasing the Renewable Energy share of Sri Lankas energy mix
Regular additions of mini hydro power plants to the national grid Completion of a 100MW wind park in Mannar by end 2014 Studies are ongoing to construct a 10MW solar PV park in the North

Budget proposals to promote renewable energy sources need to be made use of:
Tax exemption for profits and income from cultivation of renewable energy crops Concessionary income tax rate for mini hydro power/alternative energy projects VAT exemption for import/supply of raw material for manufacture of energy saving bulbs Tax exemption for solar panel modules, accessories or solar home systems Allowing higher depreciation on energy efficient plant machinery or equipment

85

Managing currently available resources in the energy sector will be a critical factor in the way forward
100 80 Per cent 60 40 20 0 Jan Feb Mar Apr May June July Aug Sep Oct Nov Dec 2010 2011 2012

Reservoir Water Level

The reservoir water levels have to be prudently used to: Ensure a favourable generation mix through 2013 Curb any losses that could be incurred due to changing weather patterns

The government has undertaken an active campaign to create awareness about energy conservation and these initiatives need to be continued
Monitoring of Energy Labelling Programmes that encourage high efficiency levels of electrical appliances Introduction of Energy Audits and Energy Efficiency measures in commercial organisations Initiation of Public Campaigns: e.g. Switch off at least one Bulb during Peak Hours, awareness programmes at schools, roadside campaigns, etc.

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Monetary policy implementation will also take into close account, global developments
In addition to domestic developments, the monetary policy regime will be closely aligned with the global business cycle. Growth and inflation developments as well as policy decisions of major economies, trading partners and competitor economies will be taken into consideration when fashioning domestic policies. International commodity prices, particularly energy prices will be carefully considered.
87

In summary, monetary policy decisions will be based on a multi-dimensional approach, which will take into account the following
Policy priorities to be pursued
Maintaining inflation at mid-single digit levels Ensuring continuous economic growth Maintaining low unemployment Maintaining Exchange Rate flexibility and stability

Direct Monetary Policy Instruments to be used

Monetary targeting measures with policy rate corridor guiding short term interest rates, with the Statutory Reserve Ratio and Open Market Operations being used to manage liquidity Managing inflation expectations through continuous policy dialogues and robust communication policy

Key stabilisation measures to be influenced

Encouraging appropriate wage inflation curtailment measures Facilitating activities that impact the ER Influencing key components of the External Account Facilitating non-inflationary sources of financing Encouraging continued fiscal consolidation and pursuing prudent management of public debt Promoting continuous productivity improvement Providing guidance for sustainable energy practices

External factors to be considered

Growth, inflation, exchange rates, etc., and policy decisions of advanced economies, competitor economies and trading-partner economies International commodity prices, particularly, energy
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Considering these expectations and concerns, key Monetary Aggregates are expected to be maintained as follows in 2013:
Dec-11 Broad Money y-o-y % change Reserve Money y-o-y % change Dec-12 (Est) 16.2 Dec-13 (Proj) 15.0 19.1

21.5

10.2*

14.5

Credit to the Private Sector y-o-y % change

* Actual

Further relaxation of monetary policy may be warranted if: Inflation and inflation expectations ease Economic growth remains below potential Aggregate demand is low Monetary and credit expansion take place at lower rates than projected Tightening of monetary policy may be considered if: Demand driven inflation and adverse inflation expectations build up Signs of economic overheating occur Aggregate demand expands at a high rate Excessive monetary and credit expansion take place

34.5

18.5

18.5

Policy Parameters as at end 2012

Repurchase rate: Reverse Repurchase rate: Statutory Reserve Ratio: 7.50% 9.50% 8.00%

89

Over the next few years, improvements in per capita income and reduction of regional disparities will bring about further major structural changes in the economy
With the economy expected to reach a level of over US$ 4,000 per capita before 2016, policies for the second wave of growth must be carefully planned in order to avoid the middle-income trap While many economies experienced their per capita incomes taking off after reaching per capita US$ 4,000 level, some economies took more than 10 years for the next doubling of per capita GDP
The key reason for these economies not taking off was a lack of diversification in economic activity
10000 Barbados Chile Dominica Greece Lebanon Mexico St. Vincent & Grenad. Uruguay Brazil Costa Rica Gabon Iran, Islamic Rep. Malaysia St. Lucia Trinidad & Tobago Venezuela, RB

8000

US$ per capita

6000

4000

2000

0 t+10 t+1 t+2 t+3 t+4 t+5 t+6 t+7 t+8 t-10 t+9 t-9 t-8 t-7 t-6 t-5 t-4 t-3 t-2 t-1 t

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That is why it is vital that the 5+1 Hubs concept is implemented effectively in order to successfully guide Sri Lanka through this barrier
Aviation Hub Tourism Hub

Maritime Hub

South Asian Economic Hub

Knowledge Hub

Energy Hub

Commercial Hub

The maturing of these economic activities will provide the diversification that is needed to move the Sri Lankan economy to the second wave of growth

91

With these diversified activities taking place, the structure of countrys earnings is likely to change materially
In the external sector, these changes will result in earnings from exports of services gaining prominence
Earnings from tourism IT/BPO Services Aviation services Maritime services Potential earnings from the Knowledge economy
Projected Receipts from the Export of Goods and Services
30 25 US$ bn 20 15 10 5 0
2011 2013 (Proj) 2014 (Proj) 2015 (Proj) 2016 (Proj) 2012 (E)

25 25 24 24 23 23 22 22 21

External Account Targets & Projections for 2016 Per Annum Value Merchandise Exports: US$ 15.2 bn of which Tea: US$ 1.9 bn Rubber: US$ 0.2 bn Textiles & Garments: US$ 5.6 bn Rubber products: US$ 1.2 bn Gems, Diamonds & Jewellery: US$ 1.0 bn Services Exports: US$ 9.8 bn of which Earnings from tourism: US$ 3.5 bn IT/BPO services: US$ 1.0 bn Workers remittances: Foreign Direct Investment: Net Portfolio inflows: Long term loan inflows: Government: Private sector: US$ 10.0 bn US$ 5.0 bn US$ 1.0 bn US$ 1.8 bn US$ 0.5 bn

Service Receipts (US$ bn) Merchandise Exports (US$ bn) Total Receipts from the Export of Goods and Services (% of GDP)

% of GDP

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46

The structural changes taking place when moving towards a US$100 billion economy, is likely to be reflected in the new Sectoral Composition of GDP by 2016, & the several mile posts to be reached
Sectoral Share of GDP - Actual and Projected
70 57.6 58 Agriculture 60 Industry Services

National Mileposts
Poverty: Less than 2% Unemployment: Less than 3% Acute Malnutrition amongst children under 5 years: Less than 5% Electricity coverage: 100% Public investment: 6% of GDP National Savings/investment gap: 0.5% of GDP

50

45.0

Per cent

40

35.9

30.7

40.6

30 19.1

12.7

20

28.7

29.7

32

Market based Targets

10

10

0 1950 1977 2009 2016 (Proj)

Value Stock Market Capitalisation: US$ 70 bn Corporate bond market: US$ 10 bn Bank assets: Rs. 10 tn

93

In the meantime, to reach a US$ 100 billion economy by 2016, Banks and NBFIs will have to play a critical role. In that regard, the Central Bank will
Review and amend the regulatory framework to facilitate the business models of banks and NBFIs Encourage the adoption of policies for diversification of business and income, through fee-based services Encourage consolidation in the banking and the NBFI sectors Strengthen the regulatory regime, while encouraging diversification of sources of funding and business operations mainly through foreign sources Enhance the quality and frequency of Bank and NBFI examinations Identify and regulate the risk profiles of banks and NBFIs in order to ensure stability of the financial sector and enhance public confidence
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47

In particular, the Capital Levels in the Banking System will be strengthened continuously
The capital levels of banks will need to grow to facilitate rising credit demand and to cushion any potential risk With the growth in Banking sector, smaller players may not be able to compete with large banks and therefore mergers and acquisitions will be encouraged for banks to be internationally competitive Banks will also be encouraged to leverage balance sheets by obtaining foreign finance
Existing Banks
Effective Date Licensed Commercial Banks (Rs.bn) 3.0 4.0 5.0 Licensed Specialised Banks (Rs.bn) 2.0 2.5 3.0

31.12.2011 31.12.2013 31.12.2015

New Banks
Year 2010 2012 2014 Licensed Commercial Banks (Rs.bn) 3.0 4.0 5.0 Licensed Specialised Banks (Rs.bn) 2.0 2.5 3.0

The capital and liquidity standards will be developed under Basel III

95

Banks will be expected to re-align their business models and processes to be in sync with the evolving needs of the economy. The 21-Point To-do-List for banks will help them to focus
1. Keep abreast of macro-economic factors, both national and international 2. Ensure that all regulatory directions of the Central Bank are followed diligently 3. Keep a close eye on the Banks capital adequacy, present and future 4. Pay close attention to corporate governance. In particular, Board practices, top management services, and regulatory responses 5. Train staff continuously, so that they are prepared for the new developments in banking in the evolving economy 6. Upgrade Information Systems for the new levels of business 7. Improve Risk Management Systems and pay close attention to local and international trends, rather than individual one-off events

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The 21-Point To-do-List continued

8. 9. 10. 11. 12. 13. 14. 15. Develop a corporate planning culture and practice it diligently Be conscious of conglomerate risk, if the Bank is a part of a group, or has associates Keep a close tab on the Banks international links and business partners with regular know your customer updates Attempt to improve the Banks rating, with at least one upgrade each year Consider new opportunities, and try to introduce new services on a staggered basis Plan for management succession as a routine exercise, not as an exceptional effort Constantly search for productivity improvements, and tighten the interest spreads to improve profitability Encourage funding lines for the 5 Hubs + Tourism initiatives of the country

97

The 21-Point To-do-List continued

16. Maintain SME focus and use the Budget 2013 initiatives for SMEs effectively 17. Support foreign remittance business, both from the sender and receiver angles 18. Support lagging provinces growth, particularly Northern, Eastern and Uva Provinces 19. Source foreign capital for Tier 1 and Tier 2 of the Bank, by using the balance sheet strengths effectively 20. Promote foreign capital inflows among the Banks clients, and help to bridge the savings gap that is existing in the country 21. Support local entrepreneurship and create new business leaders for the future

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Strengthening the regulatory regime will continue, unabated

The Banking Act will be amended taking into account the new developments in domestic and international financial markets Supervision of bank dominated financial groups will be strengthened Provisions to facilitate mergers and acquisition of banks will be introduced Bank resolution measures will be strengthened The quantity and quality of capital to improve their loss absorbency capabilities The systems and processes to migrate to advanced approaches on the Basel II capital framework The management of banking risks in an integrated manner, and The governance, fitness and propriety of directors and senior management to establish operational accountability

Banks & NBFIs will be required to further strengthen:

99

Finance Companies and Leasing Companies will continue to receive close attention
Risk focused regulatory and supervisory system will be strengthened, with a new action-based examination procedure with the introduction of integrated risk management system in NBFIs The number, extent and frequency of on-site examinations will be increased Online early warning system to identify the possible risks of NBFIs will be used The rating of LFCs will be assessed on quarterly basis A framework of macro prudential supervision to assess group risk of NBFIs will be implemented Information among other regulators will be shared to minimise contagion effect of negative development within a group Issue of new licenses for NBFIs will be stopped for the next two years, with greater focus being given to the rehabilitation processes of weak companies in the NBFI sector New prudential directions and guidelines will be formulated The adequacy and effectiveness of the corporate governance direction will be reviewed SLCs will be encouraged to convert to LFCs Investigation processes on unauthorised finance businesses will be expedited Regulatory and supervisory mechanism for microfinance institutions will be introduced

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Steps will be taken to ensure that Sri Lankas currency notes reflect an emerging, prosperous society
In particular, the Clean Note Policy will be robustly implemented with soiled notes being replaced in an efficient and effective manner Doing so will make cash transactions pleasant, and improve the image of the country
In addition, several processes will be implemented: An advanced automated cash processing system will be implemented to increase efficiency, reduce operational risks and improve working environment A more environment- friendly disposal system for unfit currency notes will be established A new series of Rs. 10 coins to depict each District, will be issued in 2013 A major Idle coin gathering programme will be launched to collect and re-issue such coins for circulation

101

An extensive regional development strategy that will focus on convenient financing of SMEs will be implemented in 2013
Giving support for business start-ups with knowledge transfers Granting Quick loans for small businesses

To support economic growth and development, the strategy will focus on:
Business start-up advice Convenient funding Appropriate safety nets Management innovation Links with large businesses Meeting regional priorities Export market access Business revitalisation

Supporting growth of SMEs Establishing sound financial footing for SMEs Supporting revitalisation of local and regional economies Granting Quick loans for agriculture and fisheries to support farmers Creating collaboration between agriculture and food industry Providing management and technical support services such as training

Providing medium term funds for SMEs Supporting innovations and business turnarounds

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Regional development activities will concentrate on the SME sector & providing affordable finance, while focusing on lagged regions/needy sectors
In 2013, nearly Rs. 17 bn worth of loans will be distributed through concessionary financing schemes implemented through the Central Bank
Loans to be Granted in 2013
Sector Amount (Rs. mn) Beneficiaries (No.)

Awareness building and training programmes for SMEs will be carried out in 2013
Programme Expected No. of Programmes 552 Expected No. of Beneficiaries 21,670

Financial Literacy for School Leavers and Loan Beneficiaries Entrepreneurship Development Training of Trainers and Bankers Post and Pre-Harvest Technology Seminars Total

32 38 12 634

1,280 640 600 24,190

New enterprises

7,000

53,700

Agriculture Diversification

9,900

117,300

103

The International Reserve Management Strategy will focus on maintaining safety of funds and maximising return in a risky global financial environment
Towards such an objective, the Central Bank will: Gradually and scientifically move to a broader array of asset classes through further diversification of its Reserve portfolio Continually build-up expertise in different trading areas of forex, commodities, securities, futures and options and other risk-mitigating derivative products Judiciously maintain an appropriate currency mix of reserves with due regard to currencies of large debt obligations and expected future developments of reserve currencies

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The countrys Payments and Settlements platform will be maintained at a level to be ahead of time
Improvements in the national payment system will be facilitated and the participation of banks and non-bank service providers in developing payment and settlement systems, will be promoted The supervisory framework and continuing supervision of Licensed Service Providers of Payment Cards will be strengthened
Expectations for the Payments System in a US$ 100 bn Economy Average No. of RTGS Transactions per day (High value payments) Average No. of

1,500

Retail Payments 500,000 The regulatory documents to harmonise the new per day developments in payment systems with the regulatory framework will be revised RTGS/SSSS System 99.9% The business continuity policy to ensure operational reliability Availability of the systematically important LankaSettle system, will be continued The risk factors to the system will be identified and policy measures to mitigate such risks will be adopted to ensure payment and settlement system stability The LankaSettle system will be assessed against the new core principles of CPSS in order to identify and address any deficiencies

105

The EPF will implement innovative fund management strategies to maximise returns in the projected low interest rate regime, while enhancing the efficiency of member services
With fiscal consolidation and the expected further decline in inflation, market interest rates are expected to decline in future, thereby providing a challenging environment for the EPF to generate high returns in the medium to long term Accordingly, the EPF will systematically continue its investment portfolio diversification policy, to provide better returns to its members. Such diversification strategy will cover: a) Equity investments that would provide for long term growth and income, b) Private equity investments that would yield higher long term returns, and c) Investments in debt securities such as corporate debentures, trust certificates and commercial paper that will provide higher annual incomes

Through such investments, the EPF will strive to provide a return that is approximately 2% higher than inflation, on a consistent basis

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53

In order to further increase the efficiency of the EPF, it will

Make it compulsory for employers who have more than 50 employees to send e-returns, which will enable the update of member accounts instantly - Nearly 80% of 2.3 million members will be covered by this scheme - It will also help to improve the Doing Business ranking of Sri Lanka Undertake image scanning of all master records of members to further enhance services Establish an e-record room by replacing the existing master files by 2014 with electronic records

107

The Central Banks in-house skills will be continuously improved to be in line with the best in the world
To support policy analysis, the Central Bank will strengthen its staff capabilities further and strengthen their analytical capabilities
3 6

This human resource pool manages/regulates:

The Central Bank Balance Sheet that exceeds a value of Rs. 1,300 bn Monetary policy to ensure economic and price stability Financial system stability by regulating and supervising a financial sector with over Rs. 6,000 bn assets The public debt of over Rs. 6,100 bn The Official International Reserves amounting to over US$ 6,800 mn The EPF funds amounting to over Rs. 1,100 bn The currency in circulation amounting to over Rs. 300 bn The payment platform that facilitates transactions totalling over Rs. 65,000 bn Properties and assets valued at Rs. 23 bn

40

PhD +Professional

129
PhD

Masters +Professional

Masters

49 104

325

Professional
Classification of Professional Qualifications Qualification Total
CA, CIMA, ACCA, CMA Law IBSL BCS CFA AAT 133 27 20 11 2 3

First Degree First Degree +Professional

108

54

On a continuous basis, the Central Bank has diligently delivered on its Growth with Stability tagline
Unit GDP GDP Per Capita GDP Growth Unemployment Rate GDP Deflator Exports Imports Workers Remittances Current Account Balance Tourist Arrivals Foreign Direct Investment Overall Balance Gross official Reserves Gross official Reserves Total External Debt End Year Exchange Rate Budget Deficit Government Debt Interest Rate (91-day T-Bill) US$ mn US$ % % % US$ mn US$ mn US$ mn % of GDP 000 US$ mn US$ mn US$ mn Months of Imports % of GDP Rs/US$ % of GDP % of GDP % per annum 1980 4,025 273 5.8 17.9 18.1 1,065 2,051 1990 8,033 494 6.2 15.9 20.0 1,984 2,686 2000 16,596 899 6.0 7.6 6.7 5,522 7,320 1,160 -6.4 400 175 -521.9 905.5 1.5 54.5 80.06 9.5 96.9 17.77 2010 49,565 2,400 8.0 4.9 7.3 8,626 13,451 4,116 -2.2 654 516 921.0 6,610.2 5.9 43.3 110.95 8.0 81.9 7.24

The Central Bank has been in the forefront of the economic renaissance of Sri Lanka during the past several years
2012 (Prov/Est) 59,253 2,922 6.5 3.9 8.5 9,751 18,679 6,007 -5.5 1,003 1,000 100.0 6,845.0 4.4 43.7 127.16 6.2 81 10.0

Key Socio-Economic Indicators 152 401

-16.4 317 42.9 -191.9 245.5 1.4 41.4 18.00 19.2 77.2 13.00 -4.7 298 41.6 118.7 435.0 1.9 72.0 40.24 7.8 96.6 17.41

In recent times the economic, social and physical landscape of the country has undergone a rapid transformation

109

If Sri Lanka is successful over the next three years, the country would surely be the next Break-out Nation and the Wonder of Asia
2012 was an extraordinary year
External and domestic challenges prompted the Central Bank to adopt strong measures to stabilise the economy. These measures resulted in swift responses allowing the Bank to relax the policy stance before the end of the year.

Today, the Central Bank is in a position to move along a more stable and sustainable path to achieve its mission of maintaining economic and price stability and financial system stability to support sustainable and inclusive growth

110

55

Over the past 6 years, we have embarked on a planned and systematic journey

2007

2008

2009

Growth with Stability

2010

2011

2012
111 112

Now, we are well positioned to

To Deliver Prosperity to

56