Sri Lanka in Resurgence after FDI and Fiscal Stimulation

Sri Lanka’s economic growth is set to outstrip India’s for the first time since 2000 as record foreign investment and government spending fuel a resurgence after almost three decades of civil war.

The island nation’s $50 billion gross domestic product will increase 8.5 percent this year, up from 8 percent in 2010 and bucking a global slowdown, Central Bank of Sri Lanka Deputy Governor Dharma Dheerasinghe said. India’s $1.7 trillion economy, Asia’s third-biggest, is likely to grow 8.2 percent in 2011 according to estimates by the International Monetary Fund, the slowest pace since 2009.

The return to peace in Sri Lanka is luring overseas money and tourists back to the tear-drop shaped Indian Ocean island. A $1 billion sale of sovereign dollar bonds last month was more than seven times oversubscribed. President Mahinda Rajapaksa’s government has pledged to spend $1 billion annually for at least three years from 2010 on projects such as a coal-fired power plant, a four-lane expressway and a container shipping hub.

‘Peace Dividend’

Dollar-denominated bond sales by Sri Lanka are attracting more investors as credit-rating companies raise their outlooks. Last month, Fitch Ratings upgraded Sri Lanka’s ranking by a notch to BB-, three levels below investment grade. Standard & Poor’s boosted the outlook for its B+ rating to positive, while Moody’s Investors Service did the same on its B1 view, citing a“peace dividend.” Moody’s and S&P rank Sri Lanka four levels below investment grade.

The Philippines, rated two levels higher than Sri Lanka by S&P, doesn’t plan to sell bonds overseas as markets are volatile, Finance Secretary Cesar Purisima said on Aug. 11. The country last sold 15-year dollar bonds in March.

Volatility Victims

Sri Lanka may still be vulnerable to a global recession should investors flee emerging markets for safe havens, according to Koen Vanderauwera, a fund manager at KBC Asset Management SA in Luxembourg. India’s stock-market capitalization is almost 60 times that of Sri Lanka’s, Bloomberg data show.

Sri Lanka’s GDP grew at the slowest pace in eight years in 2009 as a slowdown in Europe and the U.S. crimped demand for exports that account for 16 percent of the economy. Shipments, mostly garments and tea, rose an annual 34 percent to $832 million in May this year, according to the central bank.

Oil Risk

The Sri Lankan rupee has strengthened almost 1 percent against the dollar this year. Rising imports, especially“investment goods that will help achieve higher growth,” will keep the rupee stable in the face of increased fund flows, Dheerasinghe said.

Consumer prices in Sri Lanka climbed 7.5 percent in July from a year earlier compared with as much as 28 percent in 2008 while the war was raging. The monetary authority forecasts that rising food supplies and currency gains will continue to help cool inflation.

Reclaimed Land

As part of the post-war infrastructure drive, the country is targeting investment of $3.4 billion to expand its ports, looking to create a shipping hub capable of competing with Singapore and Dubai. The country’s first coal-fired power plant was finished earlier this year and next month sees the opening of a four-lane toll expressway that will slash the time it takes to travel from Colombo to the south.