Export growth inadequate to prevent large trade deficit

By the Economist

Colombo port: ‘As long as we take comfort in monthly increases in exports that are quite inadequate to narrow the trade gap, there is no solution possible’

Exports have grown and imports have grown faster. This is not a new storyline. It has been happening for almost 30 years. What’s surprising is that the official announcements once again display a sense of satisfaction in the trade performance and perhaps complacency in the growth of exports in January this year. In the same vein there appears to be unwarranted satisfaction that imports have grown by a larger proportion.

The trade deficit has increased in the first month of the year itself and continues to follow the increasing trend of recent times. If the deficit for January is projected for the whole year we may once again encounter a massive trade deficit of around US $ 3000 million. There are reasons to think this may happen as well as reasons to think that there may be mitigating factors in the international market place this year that would reduce the costs of imports compared to that of last year.

In January this year export earnings grew by 11.2 percent to $ 489.5 million from US$ 440.3 million in January of last year. Meanwhile imports grew by 15.8 percent in January this year to US $788 million compared to US $680.3 million during January 2006. Intermediate goods imports grew by 35.3 percent while consumer goods imports grew by 32.3 percent.

Consequently the trade deficit in the very first month itself is 24.4 percent higher than it was in January 2006. This, despite petroleum imports being 45.5 percent less owing to crude oil not being imported during January, as the refinery was shut down for maintenance and the import cost of refined oil being less in January owing to reduced prices.

In terms of US dollars the deficit for the single month has grown to US $298.5 compared to US $240 million in January 2005. That sounds ominous as we sustained the largest ever trade deficit of US$ 3371 million in 2006. It was 34 percent higher than the previous year’s (2005) deficit of US$ 2516 million. In 2006 too exports grew, but import increase was considerably higher. Exports grew by 8.4 percent to US$ 6883 million, while imports grew 15.7 percent from US$ 8863 million to US$ 10254, resulting in the massive deficit of US$ 3371 million. Are we set to break this record this year? We are likely to surpass the huge trade deficit of last year, if the trend noted for January continues.

The country has had trade deficits every single year since 1978. At first it was thought to be a good sign as intermediate and capital goods imports were rising and the proportion of consumer imports was declining. This pattern has persisted, though the results of the higher imports of capital goods and raw materials have been inadequate to boost exports to catch up with the increase in imports. Imports have continued to rise. Although exports too have risen, since the amount of exports has always been higher than imports, the rise in exports by even the same proportion as imports leads to a trade deficit. In fact the rise in imports has been higher than the rise in exports and therefore the deficit keeps growing larger and larger. This places a strain on the balance of payments.

Nonetheless, other items in the balance of payments have offset the trade deficit in most years resulting in a balance of payments surplus quite often. These are the remittances from Sri Lankans abroad, capital inflows into the stock market, foreign aid, loans, grants and commercial borrowings. Some of these, such as loans and borrowings are contingent liabilities. Just as they bring relief to the current balance of payments, they are a strain on future balance of payments.

So far the explanation is in terms of the statistics of the balance of payments. What about the underlying factors responsible for the persistent deficit? This aspect is the least understood and hardly ever discussed. The comfort of a balance of payments surplus and the continuing increase in exports has masked the underlying problem in the trade deficit. However last year’s massive trade deficit and the continuing trade deficit causes serious concern as foreign exchange reserves have fallen and there are expected outflows of capital this year. At the end of January the reserves had fallen to US $ 3572 million from US $ 3923 million at the end of 2005.

The difficulties in the balance of payments can be resolved by further borrowing. It is unlikely that the government would go in for relief from the IMF as the conditions they would impose are not in compliance with the government’s scant respect for curtailing its expenditure. The resort to commercial borrowing, as has happened recently, means that we would be getting into greater difficulties in future balance of payments. Already the public debt is about the size of the GDP, the goods and services produced by the economy during the year. The foreign debt component is 43 percent of the total debt.

This means that the servicing of this debt, both capital repayments and interest charges would be a further severe strain on the balance of payments of the future. The recent trend of commercial borrowing is a break from the past practice of relying on soft borrowing from multilateral agencies. The government has no option but to borrow from commercial sources at higher rates of interest owing to the stubbornness of the government’s economic and fiscal policies. The danger of this is that foreign debt servicing may become too high in the future and the country may be caught up in a foreign debt trap.

The underlying reason why the increased imports of intermediate and capital goods has not led over time to an improvement in the trade balance is that most of these imports that are generally considered inputs are not in fact inputs into export industries. They consist of items for domestic consumption such as cars and vehicles, petroleum and military hardware. Consequently the continuous large imports of these items do not result in a commensurate increase in exportable products. A more refined analysis of the import items would bear out this argument.

The unfortunate conclusion is that there is little hope of an improvement in the balance of payments in the foreseeable future. A closer and detailed analysis of the reasons for the continuing trade deficits should precede policy actions. However as long as we take comfort in monthly increases in exports that are quite inadequate to narrow the trade gap, there is no solution possible. Spiralling trade deficits, increasing strains on the balance of payments and mounting foreign debt servicing costs are inevitable.