The Central Bank expects a balance of payments surplus despite a large trade deficit this year. These expectations are based on a curtailment of imports in response to the several policy measures, higher worker remittances, increased service earnings and large capital inflows.
The projected trade deficit of US$ 9.2 billion would be realisable only if international oil prices do not escalate and export prospects do not deteriorate. The trade deficit is more likely to be around US$ 10-11 billion. Worker remittances, earnings from tourism and larger capital inflows are unlikely to be of a magnitude that would offset the large trade deficit. A balance of payments surplus appears optimistic.
 Central Bank targets
The Central Bank expects this year's trade deficit to be US$ 9.2 billion. The Bank's expectations are based on imports being contained at US$ 20.9 billion owing to the policy measures taken this year. In the first quarter of this year imports accounted for US$ 5.2 billion. The projected import expenditure is realistic provided international oil prices do not rise sharply. Export earnings are expected to be US$ 11.7 billion. This may be more difficult to achieve owing to unfavourable global conditions. Consequently, the trade deficit is likely to exceed US$ 10 billion.
The Central Bank expects the trade deficit to be offset by worker remittances of US$ 6.5 billion, tourist earnings of US$ 1.2 billion, foreign direct investment of US$ 2 billion and other capital inflows of US$ 4 billion. If these were to be realized then there would be balance of payments surplus of about US $ 1.2 billion.
There could be a shortfall in the expectations of worker remittances owing to the unstable conditions in the Middle East from where more than 50 percent of remittances are sent. The global downturn could affect remittances from other countries as well. The remittances may be about US$ 5.5to 6 billion. These should offset about 55 percent of the trade deficit. The target of US$ 1.2 billion from tourism is a realistic expectation as tourist arrivals are continuing to increase and a million tourists are likely this year.
The expectation of foreign direct investments of US$ 2 billion and other capital inflows of US$ 4 billion are less likely to be achieved. The climate for FDI has not improved and therefore a doubling of last year's figure is unlikely. Other capital inflows too may be about half of that targeted. What these shortfalls imply is that the overall balance of payments would be in deficit by about US$ 1 billion.
Trade deficit
The trade deficit in the first two months of this year at US$ 1,699 million was 60 percent higher than in the same period last year. Like in the previous year, import expenditure increased sharply and was significantly higher than export earnings. While import expenditure rose to US$ 3.5 billion, export earnings were only US$ 1.8 billion. Consequently the trade deficit in the first two months was US$ 1.7 billion compared to US$ 1.07 billion in the corresponding period last year.
This does not portend well, as this deficit projected for the year, means that the 2012 trade deficit could exceed last year's deficit of US 10 billion and could reach a much higher level if the export performance is lower and oil prices rise.
As in the past, import expenditure was the significant contributor to the deficit. Import expenditure increased by 24.7 percent to US$ 3495 million, compared to export earnings increasing by only 3.3 per cent. This feature of imports being twice that of exports constitutes the fundamental weakness in the trade balance.
Import expenditure
The reduction in consumer imports by 2.2 percent is a favourable development. It is a response to the recent policy measures. These policies may curtail consumer imports in the coming months too. Yet this development must be viewed in the context of the import structure of the country. Consumer imports are less than 20 percent of total imports and there are limits to curtailment of basic consumer imports. Therefore reduction in consumer imports alone would be insufficient.
Intermediate imports constitute the largest share of imports: 55-60 per cent of total import expenditure. Petroleum imports alone accounted for a little over 25 per cent of import expenditure. Measures to contain oil imports are imperative, especially as the oil market is highly volatile. Intermediate imports are essential items for electricity generation, are the source of power for industries and are needed to keep the country's transport functioning. However, curtailing these imports is vital for resolving the serious trade imbalance.
Investment goods imports have been rising rapidly and constitute 20 to 25 percent of total imports. Import expenditure on investment goods increased by as much as 57 per cent in the first two months. Investment goods imports account for about 25 per cent of total imports. Policies that contain these imports are also vital to reduce import expenditure. A close scrutiny of the balance of payments implications of infrastructure projects is needed to ensure that such expenditure does not lead to large trade deficits. This is especially so as export prospects are fragile.
If a serious reduction of import expenditure is to be achieved intermediate and investment goods imports have to be reduced.
Exports
The prospects of export growth are bleak. Export growth of only 3.3 percent in the first two months of the year is woefully inadequate. Industrial exports increased by only 1 percent. The country's main industrial exports, especially garments, have fared badly. Garments which are the main industrial export grew by only 1.5 percent in the two months of this year. This portends a serious problem for the future of garments. It is also of serious consequence for the balance of payments and the long-term development of the industrial sector and the economy.
Agricultural exports have not fared any better. However, the main reason for this is the turmoil in the Middle East that is a large market for tea exports. In as far as it is possible to predict, these uncertainties and difficulties in marketing tea are likely to continue throughout the year. Earnings from agricultural exports declined by 11.3 per cent, with tea exports decreasing by 15 per cent in the first two months.
Summing up
The expectation of a balance of payments surplus this year is optimistic as the trade deficit is likely to be large. Recognition of weaknesses in the export trade performance and unfavourable global and domestic developments are needed for appropriate policy responses. The adverse developments in the emerging trade picture have to be taken seriously and carefully monitored for further corrective action. What must be avoided is a complacency based upon optimistic expectations of capital inflows that may not be realised.
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