The debate on whether the country is facing an economic crisis can now be laid to rest. The evidence is too blatant that the economy is facing a severe crisis and is not fundamentally sound. The issue now is not whether we have an economic crisis, but how we face the challenges to the economy in the best possible manner. There is no need to either play down or exaggerate the extent and dimensions of the problem for by doing so we may be unable to take the essential actions to resolve the problems. We cannot allow the economic problems of the country to fester in the same manner as we allowed the ethnic problem to grow. We must face up to the problems even at this late stage and take the necessary bitter medicine. Failure to do so in the expectation that conditions would change is an unacceptable optimism.
The fundamental weaknesses of the economy have manifested themselves as a balance of payments problem. The deep-seated and basic reasons for the impasse in the balance of payments must be looked at and addressed. They require corrective actions in macro-economic management. The erosion in the foreign exchange reserves of the country occurred due to several reasons. The oil price hike and the escalation of food prices in 2007-2008, followed by the global recession are only part of the reasons for the crisis. The inability to respond to the global condition and unsatisfactory economic management are the other more significant reasons for the country’s economic problems aggravating over time. We cannot change global conditions, nor are we able to avoid their repercussions as a small trading nation. What we can do is to take countervailing actions to mitigate the problems. That is what we have failed to do in recent years.
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The basic fact of our external finances was that over the years our imports were far in excess of our exports. Consequently we had trade deficits of US $ 3656.5 million in 2007 and a massive US $ 5871.3 million trade gap last year. We have ignored the massive trade deficits owing to the large capital inflows. These have been mostly private remittances and foreign loans. On the one hand, last year’s trade deficit was too large to manage with private remittances even though these remittances grew significantly by 16.6 per cent to US dollars 2,918 million last year and financed nearly 50 percent of the trade gap in 2008.
The other strategy adopted by the government of foreign borrowing to meet the balance of payments difficulties boomeranged, as we all knew it would. The foreign loans that were borrowed had to be repaid and last year was one in which a huge proportion of debt repayment occurred eroding the foreign exchange reserves of the country. As we have repeatedly said, foreign loans that benefit the balance of payments in the current year are contingent liabilities for the future. When foreign debts are incurred for non productive purposes they become a serious burden to the balance of payments. This basic principle has been ignored in recent years. Further, the foreign borrowing was short term, at high rates of interest on commercial terms with bullet repayments.
The current balance of payments crisis has to be resolved on two fronts. On the import side, there is a need to curtail non-essential large import expenditures. On the export side, the macro economic conditions, such as inflation and the rate of exchange, must be conducive to the competitiveness of our exports.
With the conclusion of the war there must be a conscious effort to cut expenditure on military hardware. The government has the opportunity to put a cap on such expenditure and ease import expenditure. The other large expenditure is on oil imports. Despite the fall in international prices this is an item that has to be curtailed to ensure a significant drop in imports. In 2008 oil imports were 24 percent of the total import bill. In 2007 when oil prices were somewhat less and the expenditure was only slightly lower, we spent 22 percent on oil imports. Therefore a reduction in oil imports could make a useful contribution in reducing the trade deficit.
Although there is considerable attention on food imports, even last year food imports constituted less than 10 percent of import expenditure. Besides, these imports are of basic items such as wheat flour, sugar, milk and dhal. Therefore there is little possibility of these being curtailed by policy measures in the short run. A good harvest this year, particularly of rice, would help to an extent, though the impact is not likely to be that much on the trade gap. Other food imports such as fruits and sweets are quite small though conspicuous to consumers. Despite talk of self sufficiency there is little prospect of a significant increase in either milk or sugar production.
Although this discussion was with respect to exports and imports there is an important fundamental factor elsewhere that affects the balance of payments. This is the government budget. The large deficits incurred in recent years have resulted in two features that impinge on the trade balance. Government expenditure on imported items has a serious bearing on imports. We have already referred to defence expenditure. It is equally relevant for oil imports as a large proportion of oil imports too are government expenditure on official travel. The large expenditure on the public service, on personal security of a large cabinet, maintenance of large fleets of cars and their high import costs, official foreign travel are all among the expenditures that create the dent in the balance of trade and balance of payments. This is why the limitation of the fiscal deficit by curtailment of unnecessary expenditure is a vital element for reducing imports.
The other manner in which the fiscal deficit impacts on the trade balance is through the inflationary impact of the deficit. A higher inflation in the country leads to imports being relatively less expensive (if the exchange rate is not depreciated) and makes exports less competitive. Both these have in fact occurred. Therefore containing the fiscal deficit by cutting down expenditures that affect the trade balance, as well as overall government expenditure are fundamental requirements to improve the balance of payments.
The interpretation that the IMF is likely to impose the depreciation of the currency has several misconceptions. The depreciation of the currency has in any event become necessary to contain the country’s balance of payments and the low foreign exchange reserves. IMF or no IMF there is a need to depreciate the rupee to make exports viable and contain imports. That is the plain unpalatable truth. Undoubtedly such a depreciation of the Rupee would increase prices of a number of essential items that would cause hardships to people, especially the poor. It has become necessary to bite the bitter pill as measures were not taken in time to contain the fiscal deficit and introduce measures of fiscal discipline.
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