The least count of the watch used for the measurement of time period is $0.01$ s
This information is just telling you to round off to the second decimal place, as you correctly did.
The sample mean is $\mu = 0.56$ and the sample standard deviation is $\sigma = 0.02$. The answer the text is referring to is
$$\frac \sigma \mu = 0.0357 = 3.57 \%$$
But I would say that this is not entirely correct. The standard error is not $\sigma$, but
$$\frac \sigma {\sqrt N}$$
Where $N$ is the number of measurements. In our case,
$$\frac \sigma {\sqrt N}=0.009$$
So the real percentage error should be
$$\frac{0.009}{0.56} = 0.0161 = 1.61 \%$$
Update: a more careful discussion
As requested, I will try to explain more why we don't need to explicitly include the resolution of the instrument ($0.01/2$) in our calculation.
In my previous discussion I explained why the solution reported in your text was $35.7 \%$, but actually that reasoning is not really correct.
The sample mean of your data set is not really $\mu=0.56$, but $\mu=0.0556$, as you correctly wrote. But since they (incorrectly) used the standard deviation, $0.02$, as standard error, we have to round off the mean and write our result as
$$0.56 \pm 0.02$$
Because it would clearly be silly to write
$$0.556 \pm 0.02$$
because if we are not sure of the second decimal place we bother writing the third?
But if the correct standard error is used, we get
$$0.556 \pm 0.009$$
You may notice a strange thing: the number of significative digits has increased, even if our instrument had a resolution of only $0.01/2=0.005$. This is a property of the mean and it is why we use the mean in the first place: via the mean operation, we can increase the number of significative digits and circumvent the limitations of our instrument.
Take for example the case in which we have two measurements: $2$ and $7$, with resolution of $0.5$ clearly. The mean is $9/2=4.5$, so we have gained one significative place.
You can then see that with an infinite number of measurement our result becomes exact, regardless of the resolution of the instrument, because of the $\sqrt N$ term in the denominator of the standard error.