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Improve trade balance to strengthen external finances
View(s):The recent improvement in export earnings provides an opportunity to strengthen external finances and reduce debt obligations. However, careful management of the trade and services account of the balance of payments is needed to not fritter away the gains of the improving export performance. These gains could be used to improve the long-term stability in external finances.
The export performance in the second half of the year, especially in September and October, kindles expectations of a continued improvement in export earnings. The surge in manufactured exports in October is especially significant, as it is a reversal of the depressed export performance in the first half of the year. The continuation of the improved trend in exports into 2014 could improve the trade balance appreciably and bring about a balance of payments (BOP) surplus in 2014.
Export performance
There has been an increasing trend in exports from June this year that culminated with a surge in October when export earnings exceeded US$ 1 billion: a 35.1 per cent increase compared to October last year. However, export earnings grew by only 3.6 per cent in the first ten months of 2013, owing to the poor performance in the first half of this year.
Particularly noteworthy was the increased earnings from industrial exports, which account for nearly three fourths of the country’s gross export earnings, by 34 per cent in October 2013 compared to October of 2012. Textiles and garments exports grew by 46.8 per cent to achieve the highest monthly value of garment and textiles export earnings ever recorded.
Exports of garments to Sri Lanka’s major export destinations — the EU and the US — increased in October 2013: 53.2 per cent to the EU and 43.4 per cent to the US. Export earnings from rubber products, mainly tyres, also increased by 50.1 per cent in October 2013.
Economic recovery
The improvement in manufactured exports is attributed to economic recovery of the US and Europe. Their recovery is vital for the growth of manufactured exports as they account for about 70 per cent of our manufactured exports. However much the diversification of export markets is desirable for trade stability in the long run, the stark reality is that it is western markets that really matter now.
Depreciation
The improvement in trade performance could also be due to the depreciation of the rupee. By the end of August the rupee had depreciated by more than 20 per cent to a low of Rs. 135 to the US$. It has recovered in recent weeks to around Rs. 130 to the US$. The depreciation of the currency could have enhanced our competitiveness, especially by wiping out the disadvantages of the withdrawal of the European Union’s GSP plus concession.
By the same measure any appreciation of the rupee could have a setback to manufactured exports. It is therefore important to let the currency float without undue intervention by the Central Bank in the foreign exchange market as appreciation of the currency could lead to a loss of export competitiveness again.
Agricultural exports
Earnings from agricultural exports rose by 37.4 per cent in October 2013 mainly due to an increase in tea export earnings by 26.6 per cent to US dollars 147 million. This was the combined outcome of a 13.6 per cent increase in export volumes and an increase in the average export price by 11.4 per cent.
Earnings from the export of spices increased significantly by 79.9 per cent to US$ 41 million. Pepper and cinnamon export volumes increased substantially in the latter half of the year though prices declined. Diversification of agricultural exports would increase export incomes as well as stabilise fluctuations.
Caution on imports
The improvement in the trade balance in October was also due to a reduction in imports of raw materials, especially petroleum and textiles. However, it appears that the reduction in petroleum imports was due to the higher stocks from previous imports. Textile imports are likely to increase as exports of garments are increasing. Reducing petroleum imports is important as they constitute over one fourth of import expenditure and absorbs about half the export earnings. Efforts must also be made to contain imports of investment goods that have been high in recent years.
The improvement in export earnings could lead to complacency in imports. This must be avoided to ensure an improvement in the trade surplus. It is through the management of aggregate demand of both the public sector and private consumption that import demand could be contained.
Trade deficit
There is a misconception that food imports must be contained to reduce import expenditure. However, since these constitute less than 10 per cent of imports such curtailment does not improve the trade balance by much. Imports of intermediate and investment goods form the bulk of imports and have to be contained to reduce import expenditure.
Earnings from exports grew by 3.6 per cent, while expenditure on imports contracted by 1.1 per cent during the first ten months of 2013 from that of 2012. The trade deficit for the first ten months of US$ 7.2 billion suggests a reduced trade deficit this year of about US 8.8 billion.
Managing external finances
Sri Lanka’s external trade has always been vulnerable to international factors and the terms of trade have fluctuated widely. Despite the diversification of the country’s exports from primary products to a significant amount of manufactured exports, this vulnerability has persisted.
Given such an experience that will continue into the future, it is vital that when export fortunes smile, that the higher earnings are not frittered away. That is how other countries have managed to cope with the vicissitudes of trade and other global adversities such as economic sanctions, embargoes and food crises.
The prospect that the trend of increasing export earnings could continue into next year provides a golden opportunity to strengthen external finances by reducing the large foreign debt and debt servicing costs. It is the responsibility of the Government and Central Bank to use the improvement in export performance to generate a sizable BOP surplus that could be used to reduce the country’s ballooning foreign debt.