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Sri Lanka’s poor performance in exports has led to persistent large trade deficits that have in turn led to balance of payments problems and dependence on foreign borrowing.The consequent increase in foreign debt is itself a balance of payments concern as foreign debt servicing costs are a significant proportion of export proceeds.

Both last year, and in the first eight months of this year, there have been massive trade deficits. Imports have been about twice the export earnings. The trade deficit was nearly US$ 10 billion last year and is heading towards a similar figure this year.

Sustained economic growth
Sustained economic growth is not possible unless appropriate measures are taken to revive falling exports. While in the short term policies must be adopted to rein in imports to reduce the trade deficit, the long term viable solution is to increase export earnings. At the inaugural session of the Sri Lanka Economic Association (SLEA) annual sessions, Senior Minister DEW Gunasekera, the chief guest, said, “We need to comprehend the ground realities. We cannot talk of high economic growth without exports. There are no short cuts. ……. I am sorry to say the critical role of exports has not penetrated into the mindset of bureaucrats, technocrats and policymakers,”

Economists at the SLEA annual sessions stressed the appropriate policy framework needed to ensure export growth. Addressing the Technical Sessions, Sarath Rajapatirana, former Economic Advisor to the World Bank, warned that sustainable development would not be possible unless the country took measures to revive its falling export sector. Rajapatirana pointed out that the country’s export earnings had declined from 33 per cent of GDP in 2000 to 18 per cent in 2011 and estimated it to reach 15 per cent of GDP this year. Imports too have declined but at a much slower pace from 44 per cent of GDP in 2000 to 28 per cent this year, resulting in a widening trade deficit.

Appropriate policy framework
Rajapatirana brought out the vital connection between sound economic policies and export growth. Macroeconomic policy, he stressed, influences levels and rates of change of exports and imports. “And, to keep the nexus stable, governments must try to avoid, two adverse macroeconomic outcomes, namely inflation and balance of payments crises.” He pointed out that “The falling export growth trend cannot be reviewed in isolation since it is the result of international demand and domestic macroeconomic, trade and related policies.” He argued that since Sri Lanka cannot influence world demand and supply the issue has to be addressed through domestic policies that go beyond the export sector.

Fiscal management
Arguing the case for better fiscal management Rajapatirana said that the relationship of fiscal policies to export growth arises in three ways: Large fiscal deficits crowd out private sector; borrowing from domestic sources raises interest rates, encouraging inflows of portfolio capital and appreciates the exchange rate; and inflation leads to demand for higher wages, import competing activities These adverse developments, he contended, had occurred in 1982-85 and during 2006-2010.

Monetary policies
He explained: “The relationship to monetary policy comes directly from the management of the exchange rate. Allowing inflation to take place (either through monetisation of fiscal deficits or through private credit) leads to an appreciation of the exchange rate and a rise in interest rates. When the Central Bank sold foreign exchange to the market to support the rupee, it led to an involuntary open market operation since dollars are exchanged for rupees, leading to a reduction in liquidity in the domestic money market and a rise in interest rates.

Rajapatirana also demonstrated how foreign borrowing could have adverse effects on exports. Increased foreign borrowings coupled with the sterilisation of inflows lead to higher interest rates where the economy is put on an unstable path by discouraging FDIs but encouraging short term capital flows. These have adverse repercussions on the rate of export growth.

Vital policies
He elaborated on some of the vital policy measures to stabilise the economy and stimulate exports. “Fiscal consolidation” he stressed was “imperative to create conditions for strong export growth and better resource allocation. The near-term action must be on the expenditure side and raising the return to public expenditures and allowing headroom for private investment.”

He suggested that “a flexible exchange rate policy would be helpful to raise competitiveness and export growth. One cannot say what level of the nominal exchange rate will prevail. It would depend on a host of factors including future supply and demand for foreign exchange, rate of domestic versus foreign rates of interests, net capital inflows and net access to Sri Lanka’s bond market.” He advised that the exchange regime should be predictable and advised not to fix it again around Rs. 125 a dollar by using reserves.

Foreign direct investment
Foreign direct investment has an important bearing on a country’s capacity to exports. This has been amply demonstrated in the experience of East and South East Asian countries. Rajapatirana, therefore, suggested that barriers to FDI should be removed by improving the investment climate going beyond economic policies to issues of rule of law, protection of property rights and good governance. He proposed getting rid of the Termination of Employment of Workmen (special provision) Act No: 45 (1971) and Revival of Underperforming Enterprises and Underutilised Assets Act. (2011) to send a positive signal. Improved governance, better productivity, meaningful steps to mitigate corruption and a move away from protectionism in his view were essential for robust export growth.
Many of the successes in the country’s exports have been achieved by foreign investors who have brought their technology, management capacities and marketing linkages. The recent tardy inflow of foreign direct investment has been a significant factor in the lack of expansion of exports.

Macroeconomic policies and exports
The significance of Rajapatirana’s exposition was the important connection and relationship he brought out between macroeconomic policies and export prospects. Far too often strategies for export development are looked upon as specific incentives and inducements. The broader picture that is vital for export growth is neglected. Getting macroeconomic policies right such as a low fiscal deficit, keeping down inflation, adopting a flexible and realistic exchange rate policy are vital for sustained export growth. Neglect these and the micro strategies to encourage exports would fail. On the other hand, once the appropriate macroeconomic policies are right, specific methods to encourage exports could succeed. We turn to discuss these next week.

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