The "State of the Economy" report is the flagship annual publication of the Institute of Policy Studies of Sri Lanka (IPS) that analyses in detail Sri Lanka's economic performance and explores emerging development challenges for the country.

The 2010 report is devoted to an assessment of the economic challenges of post-conflict growth and stability in Sri Lanka. The decades of conflict and marginalization have left the North and East (N&E) as two of the poorest provinces in the country. The priority is not only to build up the socio-economic environment in the N&E - comparable to the rest of the country - but to do it rapidly. This means adopting a multi-pronged approach to development, which takes into account rebuilding and modernizing destroyed infrastructure, alleviating poverty by promoting economic self-reliance of households, and providing the necessary social safety nets for managing vulnerability to shocks.

Early, robust economic growth that has an immediate widespread impact will go some way towards meeting the aspirations of a post-conflict weary population. GDP growth in the first half 2010 in excess of 7.5 per cent has already signaled that a strong post-conflict economic recovery is underway. However, beyond the immediate recovery efforts must lie clear medium term policy goals that anticipate the transition to long term post-conflict economic development.

A growth boom fuelled by an infrastructure-led investment drive that relies heavily on foreign borrowing can run up against problems. For instance, high economic growth can in turn fuel rapid growth in import expenditure and raise issues of external debt sustainability in the medium term. Thus, Sri Lanka's expansionary fiscal policy stance in the midst of shrinking aggregate demand in the economy now needs to be reversed to permit fiscal consolidation. In addition to revenue enhancement, spending adjustments must be made to harness a more effective re-allocation of resources and related productivity gains that will allow economic output to expand rapidly in a sustainable manner.

The most prudent course of action is to strengthen the regulatory environment to attract increased volumes of foreign capital such as foreign direct investment (FDI) to bridge Sri Lanka's savings-investment gap.

 Regulatory impediments that impact adversely on the country's investment climate need to be addressed. These include reforms to improve public sector service delivery, reforms to improve the flexibility of labour market conditions, education sector reforms to enhance the skills set of the workforce in line with market needs, etc. In effect, this calls for improving the policies, regulations and institutions that can encourage active private sector participation of both local and foreign investors.

Harnessing the rapid recovery of Sri Lanka's post-conflict economy with a transformative process of economic reforms holds out the most promising outcome for sustained long term growth. The country has made a positive start and with a prudent management of the economy and related policy reforms, it stands poised to reap the full economic dividends of a post-conflict phase of development.