Poverty still remains at significant levels; marked disparities in regional economic activity are clearly evident; unemployment, although declining, is still high, particularly among the youth; agricultural productivity is low, resulting in low farmer income and higher prices for consumers; despite some diversification of the economy, exports are concentrated in a few commodities and a few markets, thereby increasing the vulnerability of the economy; the fiscal deficit has remained high, resulting in inflationary pressures and increasing public debt; and essential economic infrastructure remains inadequate. These concerns have been aggravated by the tragic consequences of the tsunami that resulted in the loss of so many lives and extensive destruction of property. Today, the challenge is to consider how to achieve a balanced growth with economic and social stability. Let me now highlight some of the specifics on recent economic developments and policy challenges. Macroeconomic developments Sri Lanka was able to maintain an annual average economic growth of around 5 per cent in the post liberalization era. The country’s resilience to adverse shocks has improved with a significant diversification of economic activity, particularly in the export structure. This enabled Sri Lanka to achieve a growth of 5.4 per cent in 2004, in spite of several major shocks, such as the surge in international oil prices, a severe drought in the early part of the year and floods later in the year and finally, the tsunami disaster. Per capita income has increased to US dollars 1,030 in 2004.

Monetary policy operations were made more market based and active, especially after the introduction of the independent float of the exchange rate in 2001. Monetary policy has concentrated on stability, while promoting economic growth. However, monetary expansion was somewhat above the expected path in 2004. The relatively higher monetary expansion during 2004 was mainly driven by the higher expansion in credit to the private sector as well as to the public sector. Responding to these developments, the Central Bank tightened its monetary policy by raising policy rates in the fourth quarter of 2004. The policy focus was on market stability in the immediate aftermath of the tsunami. Subsequently, after ensuring market stability, the Central Bank has conducted open market operations aggressively to mop up excess liquidity. The Central Bank will continue to mop up liquidity in the coming months. Monetary growth is expected to be contained to 15 per cent in 2005. Monetary policy will focus on restraining inflationary pressure. An area that has experienced rapid growth since liberalisation is the financial sector. This has not only contributed to economic growth in its own right, but has also facilitated growth in other sectors. The Central Bank has actively promoted financial sector stability and development by assisting in the deepening of markets, creation of new instruments and strengthening of the regulatory framework. Prospects and challenges The foregoing forms the background for the economic policies of the government. I would now like to highlight several challenges that have to be faced.