Impact Assesment

In order to develop a strategy for reconstruction it is necessary to have an assesment of damage. In thins respect, Sri Lanka was fortunate to get an early assessment done by end–January 2005 though a joint effort of the Asian Development Bank (ADB), the Japan Bank for International Cooperation (JBIC), and the World Bank (WB): "Sri Lanka 2005 Post–Tsunami Recovery Program – Preliminary Damage and Needs Assesment."⁸ This report provided a picture of the asset damage and economic losses in each affected sector and provided an estimate of the overall incremental financing needs.

The ADB-JBIC-WB assessment estimated that Sri Lanka had suffered asset damages of around US$1 billion (4.5 per cent of GDP), and estimated that the medium-term financing needs (including immediate relief) would be around at US$1.5–1.6 billion (7.5 per cent of GDP. The largest financing needs were in the housing sector.⁹ The destruction of private assets was substantial (US$700 million), in addition to public infrastructure and other assets. Loss of current output in the fisheries and tourism sectors—which were severely affected—were estimated at US$200 million and US$130 million, respectively. Key industrial, agricultural and metropolitan centers were relatively unaffected and the damage to capital assets was primarily to tourism and fisheries sectors, each of which contributes only around 1.5–2 per cent of GDP.

These aggregate figure for financing needs were quite close to the government’s own estimate of US$1.8 billion presented in February 2005 though there were some important differences at the sector level damage estimates (GOSL, 2005a).¹⁰

The Government of Sri Lanka (GOSL) subsequently (May 2005) firmed up the country’s total investment needs to be US$2 billion (GOSL, 2005b) (Table 2 [ PDF 72.8KB | 1 pages ]). The differences between these estimates reflect the government’s more ambitious longer-term plans while the donor assessment was largely geared to restoring the pre-tsunami situation.

4.1 Impact on GDP

The impact of the tsunami on the country’s immediate output as measured by the GDP figure is expected to be fairly limited—estimates range from 0.5–1.0 per cent reduction in 2005 GDP at the time of writing (September, 2005). This relatively small impact on GDP appears somewhat surprising given the extent of the asset and human losses. This is partly because only a relatively small sector of the economy was affected. It is also because the impact on current GDP measures only the loss of services from destroyed capital assets and human resources during the current year. The overall impact of the tsunami on national income is of course much larger, being the cumulative sum of such annual losses incurred in future due to the absence of the destroyed assets. The overall impact on national income over time will depend on how quickly asset replacement or rehabilitation will occur.

Further, spending on relief efforts will have an immediate positive effect on current GDP. Affected households have benefited from informal transfers by families, friends, community organizations, etc., to meet their immediate basic needs, lowering the extent to which their overall spending would fall. In fact, a significant proportion of foreign capital inflows in early 2005 reflected private transfers to tsunami affected households and regions by Sri Lankans domiciled abroad as well as funds generated through private donations. Further, some of the affected households would ‘smooth’ their consumption expenditures if they had savings or access to credit markets. The overall effect of these spending responses induced by the tsunami is to mitigate the fall in aggregate household expenditures.¹¹

4.2 Expectations and Expenditure Responses

When discussing the immediate economic impact of the tsunami, and likely spending effects, it is important to factor in changes in community expectations. Spending and savings decisions are strongly influenced by expectations held about future incomes and spending needs. A large natural catastrophe that destroys capital assets and consumer durables can sharply lower expectations of all future income flows. In other words, there is a reduction of the overall wealth available for consumption over their lifetime. When people experience a reduction in their wealth position, a common response is to cut down on spending to adjust to their lower wealth position. On the other hand, if the fall in current income is not expected to be ‘permanent’, then people will dig into savings or borrow, in order to maintain consumption levels.¹²

In Sri Lanka’s case people’s expectations were dramatically affected by the immediate response of the international community which promised massive assistance to tsunami affected communities and countries in the form of aid flows and debt relief. The impact of these promises on the Sri Lankan community was immediate and tangible.

There was a discernible lifting of spirits and a surge of optimism about the future. This optimism was further strengthened by hopes of an enduring peace in the country based on the cross-ethnic community solidarity shown in the immediate aftermath of the tsunami.

The most visible sign of this almost euphoric mood of optimism following the tsunami was in foreign exchange markets (and subsequently in the Colombo stock market). The rupee reversed its long and sustained depreciation and sharply appreciated (Figure 2 [ PDF 33.7KB | 1 pages ])—a reaction seemingly so perverse and unexpected, but understandable in the context of the change in expectations. In fact, in the absence of Central Bank intervention, the appreciation may have been even more pronounced. This issue will be taken up in more detail later.

The views expressed in this paper are the views of the authors and do not necessarily reflect the views or policies of the Asian Development Bank Institute (ADBI), the Asian Development Bank (ADB), its Board of Directors, or the governments they represent. ADBI does not guarantee the accuracy of the data included in this paper and accepts no responsibility for any consequences of their use. Terminology used may not necessarily be consistent with ADB official terms..

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