The government’s move to reduce the tariffs on car imports in 2010 was a miscalculation and now increasing these duties will not restrain the trade deficit as it was done way after the problem occurred, Dr Nimal Sanderatne, eminent economist and the Sunday Times economic correspondent says.
Too late
"Reducing tariffs on motor vehicles by as much as they did was a mistake. Slapping high duties on them now is like closing the stable door after the horses have bolted," he told the Business Times. He also cautioned that this measure isn't likely to contain the trade deficit much. “The pent up demand for motor vehicles has already been satisfied and there are huge stocks of imported cars already in the country. The IMF says selective tax measures such as the recent hike in car tariffs is not an appropriate policy move even though they agree that the liberalisation of car imports was one factor that increased import expenditure,” he explained.
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The IMF says that it is inappropriate to do selective tax increases to contain the deficit and that more generalized instruments that are less discriminatory and apply more across the board should be adopted. "There are needs for across the board measures but selective measures too have a place owing to the differences in priorities of imports,” Dr. Sanderatne noted.
He said the IMF agreeing to release another tranche of its standby loan facility is of significance not only because of the foreign exchange released, but also the international confidence it would generate. "As the IMF Resident Representative Dr Koshy Mathai observed the IMF is happy that the government is taking the balance of payments problem seriously. Recognising that we have a serious balance of payments problem is the first step towards remedying it,” he said.
He added that there were misconceived ideas about this loan such as the notion that Sri Lanka didn’t need it. “There was even a hint that the IMF money of the last tranches that had been withheld owing to government’s inaction would be unnecessary. It was argued, quite falsely, that if the remaining two tranches are taken that the interest rate for the entire IMF loan would increase. This was incorrect as the higher interest rate was applicable only to the remaining tranches,” he explained.
IMF loan vital
He also noted that the interest rate applicable to the IMF loan was much lower than what the government was paying for its commercial borrowing. “The IMF loan was vital for restoring international confidence, at least to some extent," he added.
When asked why is there a lack of seriousness about the ballooning trade deficit (by the authorities), Dr Sanderatne said that the Central Bank’s (CB) view is that the huge trade deficit would be offset by worker remittances, earnings from services, foreign direct investment and other capital inflows. “There was an impression created that it was a temporary turbulence that would soon pass away," he said, noting that this complacency was due to the CB continuously emphasising that exports were growing by a significant amount rather than pointing to the widening trade deficit.
He said that exports growth at 22% last year which was inadequate compared to the imports growth by 50% was underplayed. “The plain truth was that import expenditure was so large that services incomes, workers’ remittances and other capital inflows were woefully inadequate to meet import expenditure. Workers’ remittances that financed 97% of trade deficit in 2009 and 84% of the deficit in 2010 could finance only 53% of the deficit last year. Although workers’ remittances increased by as much as 25% the trade deficit had increased so much that it was ineffective in offsetting it by much," he explained.
Difference of opinion
Dr Sanderatne noted that there’s a slight difference of view between the government and IMF about the extent of the needed increases in interest rates. “The IMF says that the increase in interest rates is still inadequate to meet the problem of excessive demand that increases the propensity to import. This may be so, but market interest rates are rising much above policy interest rates, so demand may be contained. In fact the Central Bank has increased policy interest rates further.”
The balance of payments problem is so large that there are no easy ways of resolving this, according to Dr. Sanderatne. "There is a misconception that the problem can be solved by containing consumer imports. Last year consumer imports accounted for only 20% of total imports and food imports were only 10% of the import expenditure. There’s a limit to reducing such imports as most are essential imports. When increasing prices of wheat, sugar, milk powder and other essential food imports you increase their prices but reduce imports inadequately, since their elasticity of demand is low. The decrease in the amount demanded does not decrease by much,” he stressed.
He said it’s important to reduce intermediate and capital goods imports, noting that it’s a half truth that these imports are ‘essential’ for the country’s economic growth. “Intermediate imports constituted 56% of import expenditure. Petroleum imports were as much as nearly 25%. Unless some of these imports are curtailed significantly you can’t make a dent in the trade deficit.”
He said it is difficult to reduce oil import expenditure and that increase in oil import expenditure is due to both increased imports and increased prices. “We are not in a position to control international oil prices which are very volatile. We need to curtail our petroleum imports. Increased prices would reduce consumption, but not much. Other limitations may have to be imposed such as limits on travel days,” he explained, adding that reducing government expenditure on petrol should be rationed by reducing the allocation. Similarly lighting, air-conditioning and electrical usage in public buildings should be reduced, he said noting that there’s no point in asking households to reduce consumption of electricity when there is conspicuous consumption of electricity by the government.
He added that one of the reasons for the widening of the trade gap has been the substantial increase in investment goods imports by 60% last year. "Infrastructure investments don’t contribute to economic growth but they lead to a huge leakage into imports. Machinery, transport equipment and building materials constitute a high proportion of these imports. When investment expenditure does not increase export earnings or reduce import expenditure they create serious balance of payments difficulties.” |
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