Sri Lanka's Defense Spending to Rise 20% to Record

Sri Lanka's Defense Spending to Rise 20% to Record (Update3)

By Anusha Ondaatjie

Oct. 10 (Bloomberg) -- Sri Lanka's government will boost spending on defense and public security by 20 percent to a record next year as the South Asian nation experiences its worst fighting with Tamil Tiger rebels since a 2002 truce.

Defense ministry outlays are forecast to rise to 166.4 billion rupees ($1.5 billion) in 2008 from 139 billion rupees a year earlier, according to the government's Appropriation Bill tabled in parliament today. The legislation gives expenditure estimates ahead of November's annual budget.

Sri Lanka's economic growth will slow this year, Central Bank Governor Nivard Cabraal said last month, constrained by the highest interest rates in Asia and renewed violence. Fighting has worsened after attempts at talks between the government and the Liberation Tigers of Tamil Eelam last year failed to restart a peace process aimed at ending a two-decade civil war.

``Peace is the single most important thing for Sri Lanka's economy,'' said Vajira Premawardhana, head of research at Lanka Orix Securities Ltd. in Colombo. ``This year's targets will be difficult and with defense expenditure on the rise, next year looks tough too.''

A further deterioration in the security situation may adversely affect Sri Lanka's credit fundamentals possibly resulting in a downgrade, Paul Rawkins, a London-based senior director at Fitch Ratings, said in a report on Oct. 8. In April, Fitch retained its negative outlook on the South Asian island's BB-, three levels below investment grade, rating because of the violence and weak state finances.

Growth, Deficit Concerns

Governor Cabraal expects growth in the $26 billion economy to slow to 7 percent this year from 7.4 percent in 2006, before picking up to 8 percent in 2008 as infrastructure spending limits the impact of worsening tensions. Citigroup Inc. expects growth to ease to 6 percent this year.

President Mahinda Rajapaksa aims to narrow the budget deficit to 7.2 percent of gross domestic product this year from 8.7 percent in 2006 even as defense spending increases.

``The government's emphasis is on the military option and there's no holds barred when supplying the military,'' said Jehan Perera, director of the National Peace Council, a Sri Lankan non- governmental peace advocacy organization. ``It will mean a paucity of funds for development.''

Air Attack

Unrest discourages private investment and hinders the flow of goods to and from the north and east of the island, where the fighting is taking place.

Sri Lanka's military has increased operations against the LTTE in the north since capturing the Eastern Province in July. The LTTE has said it will respond to the army's offensives by targeting oil and army installations.

The rebels launched an air attack on oil and gas facilities near the capital Colombo in April, forcing some overseas airlines to withdraw and leading to the closure of the international airport for flights at night in May and June. The LTTE unveiled an air wing with a March 26 attack that killed at least three air force personnel at the Katunayake base, which shares its runway with the island's main Bandaranaike airport.

The government said it reopened the airport after boosting its radar and air defense systems. India and Sri Lanka earlier this year began joint patrols in the Palk Strait to combat the LTTE, which also has a unit known as the Sea Tigers comprising about 4,000 of its 12,000-strong force of fighters.

Borrowing Costs

The government says borrowing costs at a five-year high have helped to rein in inflation fanned by increased oil prices and higher import costs because of a depreciating currency. Cabraal has kept the central bank's benchmark interest rate at 10.5 percent for seven straight monthly meetings.

Barclays Capital, HSBC Holdings Plc and JPMorgan Chase & Co. this week began marketing Sri Lanka's first overseas bond sale in Asia, Europe and the U.S. The central bank said in July it wanted to raise as much as $500 million as soon as September to help upgrade the country's infrastructure. The debt sale will also serve as a benchmark for Sri Lankan companies raising money in international capital markets, the Colombo-based bank said.

``The government will be looking at higher tax collection and the foreign borrowing component to ease the pressure on domestic interest rates,'' Premawardhana said. ``The higher cost of doing business will filter through to slower growth.''

Sri Lanka's government plans to increase spending by 15 percent to 1.5 trillion rupees next year, as it builds more roads, ports and bridges to bolster economic growth.

Sri Lanka plans 790 billion rupees of capital expenditure next year, the government's Web site said on Sept. 28, citing Deputy Finance Minister Ranjith Siyambalapitiya. The government will present the 2008 budget in parliament on Nov. 7.

The government expects to keep defense spending at about 3 percent of gross domestic product this year and is likely to meet its budget-deficit forecast because of higher tax receipts, Treasury Secretary P.B. Jayasundera said in a June 7 interview.

To contact the reporter on this story: Anusha Ondaatjie in Colombo, Sri Lanka at anushao@bloomberg.net .

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