However, overall economic progress has been below the desired level for a sustainable reduction in unemployment and poverty in Sri Lanka. Sri Lanka’s inflation has averaged 11 per cent in the post liberalization era. This has the adverse consequence of eroding the living standards of people, particularly vulnerable groups such as pensioners, other fixed income earners and the poor. Supply side factors, including sharp increases in the price of oil imports, have contributed to cost-push inflation. Sri Lanka’s vulnerability to the vagaries of weather, and relatively low agricultural productivity have been causal factors. Monetary management has been able to contain demand-pull inflation to a degree. The increase in inflation in 2004 over 2003 was perhaps typical - caused by a prolonged drought in certain areas of the country, a rise in international prices of key commodities, especially fuel, a somewhat higher growth in money supply and an increased budget deficit. Investment and savings ratios have been moderate; not sufficient to raise economic growth to the level necessary to improve the standards of living to the desired degree. Investment improved in 2004 to 25 per cent of GDP. However, a level of about 30 – 35 per cent of GDP is required on a sustained basis over the next five to ten years to improve essential infrastructure, to promote a higher and regionally balanced growth. BIS Review 36/2005  1  The external sector has been developing rapidly since 1977 with a significant degree of export diversification.
External trade expanded considerably in 2004 with an increase in both exports and imports, benefitting from the fastest global economic growth recorded in the past few decades. Trade deficits have been mitigated by increased worker remittances, and inflows from services, mainly tourism and port services. The flexibly managed exchange rate regime has helped to maintain Sri Lanka’s external competitiveness. Throughout the post liberalization era, fiscal deficits have been high due to heavy public investment in the early eighties and high defence expenditure from the mid eighties until the signing of the ceasefire in 2002. This has led to the public debt rising to over 100 per cent of GDP, a cause for concern. Recognising this, the government made a commitment to strengthen the fiscal consolidation process with the enactment of the Fiscal Management (Responsibility) Act (FMRA) in 2002, designed to reduce the budget deficit and outstanding debt in the medium term. The Economic Policy Framework of the new government emphasises the need to increase government revenue, in the fiscal consolidation effort, while maintaining an adequate public investment programme to improve the quality of the infrastructure in the country. The framework of monetary management has continued to be improved since 1977 to increase the effectiveness of monetary policy. Indirect policy instruments are now the primary means of monetary management. In order to make the operations of the Central Bank more focussed, the twin objectives of economic and price stability, and financial system stability, were designated as the primary objectives of the Bank in 2002.