Growth in GDP was estimated at 3 percent in 1987, down from 4.3 percent in 1986, and the lowest level in a decade (see table 7, Appendix A). By 1987 it was clear that the ongoing civil unrest was causing serious economic difficulties, mainly because rapidly increasing defense outlays forced the government to cut back capital expenditure and to run a large budgetary deficit. Concern over the decline in foreign investment and extensive damage to infrastructure mounted as sectors such as tourism, transportation, and wet rice farming suffered production losses directly related to the decline in security.

By early 1988, the ethnic conflict had resulted in extensive property damage. Infrastructure damage in Northern and Eastern provinces was estimated at Rs7.5 billion in August 1987 and was expected to be revised upwards to include the widespread destruction in the Jaffna Peninsula (see fig. 1). In the predominantly Sinhalese areas, riots against the 1987 Indo-Sri Lankan Accord caused damage to government property estimated at Rs4.8 billion (see Foreign Relations , ch. 4).

In early 1988, future economic prospects were closely linked to the security situation (see Primary Threats to National Security , ch. 5). Late the previous year, the government succeeded in obtaining commitments from foreign nations and international organizations to finance an extensive reconstruction program for the 1988-90 period (see Foreign Aid , this ch.). If there were a pronounced ebb in the political violence plaguing the island nation, it would be probable that the official target of Rs80 billion foreign aid over this three-year period would be reached. Aid on this scale, which would be a substantial increase on the already generous levels received, would not only enable the rebuilding of infrastructure destroyed by the violence but also fuel growth and allow the large trade and budget deficits to continue. Accordingly, the 1988 budget foresaw a sharp decline in defense spending and an increase in capital expenditure. These economic plans, however, depended on a peaceful solution to the country's political problems. If political violence escalated in subsequent years, not only would the government have to shift its spending back to defense, but some of the expected foreign aid probably would be suspended.

Data as of October 1988