**8 |** P a g e

direction of change was the same as in exports. But the expansion in import demand for transportation services was much stronger as an average share of 58 percent in 1995-2003 increased to 63 percent in 2004-10. Since the gap between imports and exports of these services has been traditionally the largest amongst other commercial services, this dynamic has contributed to worsening of enduring deficits in trade in commercial services.

Sri Lanka has been running large deficits in its external trade in both goods and services. The exports coverage of imports of goods and services was never close to 90 percent in any year single over 19952010 with the average ratio of 79 percent during this period. It reached the maximum value of 87 percent in 2001. Subsequently, the ratio fell to 65 percent in 2008. Since imports fell more than exports in 2009, the coverage increased to 77 percent only to fall back, according to preliminary estimates, to 66 percent in 2010 (see Figure 2 above). In terms of the GDP, the deficit ranged between 6 percent in 2002 and 13.5 percent in 2008. A much larger contraction in imports than in exports in 2009 brought the trade deficit down to 6.5 percent of the GDP in 2009. Deficits were consistently recorded in both goods and services balances, expect in 2009 when the services balance was positive due to cuts in imports (Table 1).

**Table 1: Trade balance in goods and services, FDI inflows and workers’ remittances in 2001-10 (in millions of US dollars and percent)**

||2001|2002|2003|2004|2005|2006|2007|2008|2009|2010|
|---|---|---|---|---|---|---|---|---|---|---|
|Goods and services|||||||||||
|balance, of which|-954|-1,112|-1,140|-1,824|-2,179|-3,114|-3,354|-5,469|-2,731|-5,269|
|goods|-560|-796|-872|-1,443|-1,630|-2,345|-2,527|-4,470|-3,122|-4,050|
|services|-394|-316|-268|-381|-549|-769|-827|-999|391|-1,219|
|Memorandum:|||||||||||
|FDI inflows, net|172|197|229|233|272|480|603|752|404|478|
|Earnings from|||||||||||
|tourism|195|251|340|416|362|410|384|320|349|576|
|Remittances, net|984|1,097|1,205|1,350|1,736|1,904|2,214|2,565|2,927|3,608|
|Total above in|||||||||||
|percent of balance|**142%**|**139%**|**156%**|**110%**|**109%**|**90%**|**95%**|**67%**|**135%**|**88%**|

Sources: IMF BOP data and World Bank WDI database. Earnings from tourism as reported in Annual Statistical Reports of Sri Lanka’s Tourism published annually by the Sri Lanka Tourism Development Authority.

Foreign direct investment, foreign exchange earnings from tourism and workers’ remittances have played an important role in financing trade deficits, although their economic significance was different. In terms of the balance of trade in goods and services, aggregate net inflows from these sources were larger than deficits except in 2006-08 with remittances towering over them. Depending on the year they were between around two (in 2002-04 and 2008-08) and four times (in 2010) larger than aggregate FDI inflows and foreign exchange revenues from tourism in 2001-10. In terms of the GDP, they averaged at 6.7 percent in 2001-10 reaching around 7 percent in 2009-10.

Both revenues from tourism and FDI inflows to Sri Lanka—very similar in terms of magnitudes—have been very small. Neither of them exceeded 2 percent of the GDP in 2001-10. In spite of the end of civil war in 2009, FDI inflows, in part because of their worldwide decline due to the global financial crisis in 2008-09, fell to 0.9 percent in both 2009 and 2010 from 1.9 percent of the GDP in 2008. Revenue from tourism increased in 2010 from 0.8 percent of the GDP in 2009 to 1.2 percent.

Although they are all sources of foreign exchange inflows and help finance deficits in international transactions, FDI stands apart from two other sources. FDI is not only a source of funding current account deficit but also an important conduit of technology diffusion critical to upgrading a country’s