On the eve of another national New Year, it is appropriate to ponder on the responses of the country to the several challenges that face the country’s economy. This is especially so with respect to whether there are specific ways in which we should respond to recent global developments that were discussed last week. Do the recent global developments require a redirection of economic policies? What are the ways in which the country must respond to be less vulnerable to escalating global prices of essential commodities? Among the issues that may require policy responses are the escalating international oil prices, increases in food and other commodity prices and the loss in remittances income owing to the flare-ups in the Middle East.
 Short term and long term
In the first instance there is a need to make a distinction between short term turbulences and long term developments. There are also limits to which the country could take adequate measures to meet the emerging problems as the resources and capacity of the country is an important determinant of what can be done. Emotive grand designs are not likely to be of much use. Realistic responses to the emerging global developments are what are needed. This is particularly so with respect to how the country should respond to the international food crisis.
The needed responses are no different to what economic policies should have been before any of the global problems arose. Therefore the overall answer to the question is that there are no special responses needed in the long run development strategy, though some short term changes are needed to cope with the current developments. Good economic policies are ones that ensure resilience in the face of economic turbulences and continue to strengthen the economy in the long run. Nevertheless, short term responses are needed to ensure that the disadvantages are minimized and to stabilize the economy in the face of temporary crises.
Short term responses
The oil price hike is the classic case of a need for a short term response within a longer term framework of policies. Last week international oil price increases were passed on to consumers. The increase in oil prices to the levels it has reached is a temporary phenomenon. It is not only the political unrest and attacks on Libya and the no fly zones that have caused the price increases, but speculators have increased prices by their bidding up prices much above what the supply demand situation warrants. In fact the loss of oil due to the current Middle East crisis is very limited, but the impact of it through speculation has been significant. There is both a need for an immediate response so that the price hike does not lead to a destabilization of the economy, as well as a response that will cope with the instability, fluctuations and uptrend in fuel prices.
Aligning domestic fuel prices to international prices, however unpopular, is imperative. Even before the recent international price increases, the Ceylon Petroleum Corporation (CPC) was incurring large losses by giving oil at lower prices to the Ceylon Electricity Board (CEB) and subsidising consumers of kerosene, diesel and petrol. The lowest subsidization was of petrol. The consequence of this subsidy was that it increased government expenditure and the fiscal deficit that in turn causes inflationary pressures.
Therefore, however politically unpopular it is, from a fiscal and economic point of view it is important to keep domestic prices aligned to international prices and to improve the efficiency of the CPC to reduce losses. There is another dimension to it that places the economic decision making in a dilemma. The increase in fuel prices leads to increases in the costs of living. It increases prices directly as consumer prices of three key commodities, kerosene, diesel and petrol are raised, and indirectly through its impact on transport costs that increase prices of most domestically produced goods including basic food items such as vegetables, rice and fish. Therefore there is a justification of a subsidy on the grounds of keeping prices of essential commodities and transport down. If the price increase of crude oil is considered very temporary, then there is good reason to give such a subsidy for a time.
The other aspect is that if prices are not increased consumption would not be contained. This is why it is recommended that oil price increases be passed on to consumers so that there is a reduction in demand. Otherwise, from a balance of payments position the price increases create huge import expenditure. Oil imports are the largest import expenditure costing about 60 per cent of imports and absorb an overwhelming proportion of export earnings.
Long term response
The long term response is clear. Oil dependence must be reduced as much as possible by the development of alternate energy sources, such as hydro, coal, wind and bio gas. Conservation in energy use must be brought about by awareness, pricing policies andexample of the government and public institutions. There is far too much of conspicuous consumption of electricity that could be curtailed. With all these suggestions being implemented the country is likely to be heavily dependent on oil imports. Therefore the affordability of such oil import expenditure would depend on export growth. This is the case of many countries that cope with high oil prices by the robust growth in exports.
Food prices
The international increases in food prices have both a short term and long term causality. The floods, droughts, fires, earthquakes aggravated a long term trend of a mismatch in supply and demand for food. International food supplies were not increasing with population increases in the last decade as a secular decline in food grain prices were leading farmers to convert lands to bio fuels, vineyards and non-agricultural uses. On the demand side, the demand for food was increasing owing to population surges and increases in demand for food especially from Asia’s giants whose rapid development was increasing the need for more food. In China it was not merely an increase in demand for grains but also increased demand for meats that in turn require larger quantities of grains as animal feed. This is the underlying trend that has resulted in “NO cheap Food”. Speculators add a further escalation of prices especially at times when food shortages are evident.
Agricultural policies
This is the backdrop in which Sri Lanka’s agricultural policies have to be formulated and implemented. What it implies is that the country must produce more food and be more self-sufficient. However this must not be achieved at any cost as high cost production means consumers would be adversely affected and access to food would be restricted to the poorer sections if food prices are high. Land and water resources that are vital for agricultural production is a limitation. The implication of this is that productivity increases are necessary.
Agricultural productivity increases have been inadequate. In the staple rice the country’s average productivity at about 4.5 tons per hectare compares well with most countries in the region but much less than the potential. The potential yields are at around 11 metric tons per hectare. Although the average yield cannot be expected to be as high due to agronomic and resource constraints, it should be possible to increase yields to about 6 metric tons per hectare. This would make the country more than self-sufficient; enable a sufficient sock to be built up in the good years and enable excess supplies to be used to produce rice based products. The productivity of other food crops too is below potential yields. Given very little possibilities of expanding the cultivation area, increasing yields is vital to supply more food at reasonable prices.
Remittances
The economy has become heavily dependent on remittances from abroad. Last year about 80 per cent of the huge trade deficit was financed by remittances. Remittances are not likely to rise as in the recent past till some stability returns to the Middle East. However the reduction in remittances is not likely to be large.
An important lesson however is that heavy dependence on remittances should not blind us to the weaknesses in the country’s economic fundamentals that cause massive trade deficits. Export competitiveness and export diversification must be achieved to reduce the trade deficit.
Conclusion
The challenges posed by the global crisis should be an opportunity to address fundamental economic weaknesses. Oil dependence should be reduced by developing alternate sources, conservation of energy use and appropriate pricing policies. Agricultural production must be increased by productivity increases. Improvements in economic fundamentals must spur export growth and more diversified exports that should reduce the dependency on remittances.
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