The economic impact of the global recession

By the Economist

International economic developments are likely to affect the country’s economic performance adversely this year. Global economic developments that are of utmost significance for the Sri Lankan economy are ominous Sri Lanka is an island economy that floats on international waters whose tides rock it frequently. It is highly dependent for both exports and imports. In fact this dependence is not recent; it dates back to the early years of the nineteenth century.

Over the last sixty years since independence that dependence has not been reduced, though the nature and character of the dependence has changed. In the first three decades after independence it was an import export economy, where both exports and imports were agricultural. The exports were tea, rubber and coconut and the major imports were rice, wheat flour, sugar and a range of other food commodities. In the last three decades that has changed drastically. The main exports now are industrial commodities, while the main imports are petroleum, industrial raw materials, capital goods and war related hardware and ammunition. The country is therefore highly dependent on international markets and therefore global developments are of paramount consequence to the performance of the economy.

The expected international economic developments this year are not encouraging. Overall global economic growth is expected to slow down. According to the World Bank the global economy is expected to slow down to a modest 3.3 percent growth. Most of this slower global growth is in high-income countries. It could be worse if the United States slips into recession that many analysts expect would be the case. The current view is that there is a 50-50 percent chance of a recession. The cut in interest rates by the Federal Reserve is expected to spur demand. Whether it would succeed is left to be seen. However a World Bank study points out that the slowdown in the United States, the world's largest economy, is being partly offset by the resilience of developing countries, which have powered through four consecutive years of record expansion. The US economy is expected to grow by only 1.9 percent in 2008. What this means for us is clearly stated in these words. "External demand for the products of developing countries could weaken much more sharply and commodity prices could decline if the faltering US housing market or further financial turmoil were to push the United States into a recession."

There is some controversy with respect to economic prospects in the 15-nation European Union The World Bank is of the view that these countries would suffer in this environment and that growth would decline more than a half percentage point to 2.1 percent in 2008. Some European observers are of the view that these countries are resilient and that the US recession would not affect them. The Japanese economy too would grow by only 1.8 percent this year.Developing country growth is expected to slow down only moderately. Real gross domestic product (GDP) growth for developing countries is expected to be 7.1 percent in 2008, while high-income countries are forecast to grow by a moderate 2.2 percent. The report highlighted an acceleration of industrial production in the developing world in the first half of 2007 that buoyed economic growth. China, India and Russia were crucial in raising output. The Bank estimated GDP in East Asia and the Pacific grew by about 10 percent in 2007, with China up by more than 11 percent. Growth for the region was expected to decelerate to 9.7 percent in 2008 and to 9.6 percent by 2009.

What is most important for Sri Lanka is the economic developments in western countries, particularly the United States as they are the significant markets for our industrial goods. The economic slow down in the developed countries would affect Sri Lankan exports adversely. Many of the country’s industrial exports like garments, rubber gloves, leather goods etc are sensitive to income changes in the developed countries. The slowing down of income growth in the US is likely to affect garment exports in particular as the US is the main market for these. Past experience is that rubber goods too were affected by slower growth in developed countries and picked up with the economic recovery of these countries. Furthermore, our competitiveness could be eroded by the high rate of inflation that we are experiencing and the high price of electricity, petroleum products and other raw materials that raise the costs of production. Consequently, 2008 will be a challenging year for our industrial exports.

The story is very different with respect to our agricultural exports, especially tea and rubber. Both these exports are likely to see a continuation of the uptrend in prices experienced recently. In the case of tea, international tea production for export is likely to be reduced owing to the political upheaval in Kenya that is the second largest tea exporter and main competitor for Sri Lankan tea. The rise in petroleum prices has resulted in an escalation of synthetic rubber prices with advantage to natural rubber. These advantages cannot be exaggerated as the capacity to increase their production is limited. Tea production fell in the last two years from the peak level of 317 million kilogrammes achieved in 2005. This year’s tea production and exports would depend very much on industrial peace. The continuing inflation, especially the rise in costs of basic commodities like rice, wheat and sugar are likely to exert demands for higher wages and perhaps industrial unrest. This is a real danger. Weather conditions over which we have no control could be the other determining factor. The shrinkage in the extent of rubber cultivation means that the capacity to increase rubber production is quite limited.

In contrast the import side would be a continuation of the adverse trends of the last two years. Oil prices are expected to be very high and possibly increase by about five dollars during some parts of the year. It may even rise from its current high level of US$ 100 per barrel to US$ 105 this year. The short supply in agricultural commodities too would hit us adversely. Prices of wheat, sugar, milk and other commodities are likely to remain high. The inflation that we are experiencing is likely to continue during this year.These developments are likely to result in a large trade deficit once again. The dent in the trade balance would be caused mostly on the import side where the import expenditure is likely to rise much faster than the export side. Where the export side is concerned, any adverse effects of lesser demand for industrial exports may be offset by higher prices for tea. Nevertheless a sharp increase in exports can hardly be expected. These global developments are beyond the control of the country and the authorities.

Their impact has to be recognised and countervailing policies have to be adopted to reduce their impact. A passive position that these global developments are beyond our control, without remedial policies would only lead the economy into dire straits. The most important measures would be the reduction in government expenditure, especially on imports, and fiscal measures, rather than monetary controls, to curb domestic inflation. Unfortunately the relationship between government expenditure, inflation and the trade deficit appears not to be understood or there is a stubborn streak to take policy measures owing to political considerations.