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Higher manufactured exports improve economic growth prospects
View(s):The better performance of the country’s exports in the first two months of this year has led to an expectation that the economy would do well.
Although both agricultural and manufactured exports increased in the first two months of this year, it is the growth in manufactured exports that is noteworthy, as it could have a significant impact on the economy. It could expand industrial production and trade related services and contribute to the country’s economic growth. It is an improvement from the recent growth experience generated by debt financed infrastructure projects and increased public employment.
While this improvement in exports would contribute to economic growth, a few months or even one year’s growth is not sufficient to project medium-term growth prospects. That would depend on permanent factors, such as higher and better spending on education and improving the incentive structure in addition to maintaining near-term macroeconomic balance. This improvement in exports should spur the expansion of export surpluses, diversify into new products and search for new markets.
Despite this export growth, macroeconomic fundamentals remain weak. The high fiscal deficit, high indebtedness, large trade deficit and limited head room for private sector activity continue to be constraints to economic stability and growth. These are fundamental problems that must be addressed. The higher growth this year should be used to strengthening these weak economic fundamentals.
Export growth
The growth in manufactured exports is due to the economic recovery of the US and European Union countries, Sri Lanka’s main export markets. The improvement in manufactured exports that began in the latter half of last year has gained momentum and the first two months’ increase in export earnings leads to an expectation that export earnings would grow this year.
An analysis of market trends indicates that the demand for garments that accounts for about 60 per cent of manufactured exports would increase in these countries. This augurs well for industrial growth provided the garments and other industrial exports remain competitive.
Trade deficit
Although agricultural export earnings increased significantly in the first two months, the prospect of increased agricultural exports this year is dim as production of tea, rubber and coconut are not likely to be high. Unless the reduced exportable surplus is compensated by higher international prices, agricultural export earnings are likely to decline. Fortunately, current expectations are that tea prices would be robust enough to offset the drop in export volumes.
Even though the trade deficit has been reduced and appears to be a significant improvement from that of the first two months of last year, the trade balance is not as healthy as conveyed by this comparison of the first two months of these years. The trade deficit in the first two months was US$ 1.26 billion. A simple linear extrapolation of the trade balance of the first two months gives a trade deficit of US$ 7.56 billion.
Exports are still only a little more than half the value of imports (58 per cent). Exports have to be increased much more over the next ten months to reduce the trade deficit significantly. Exports should exceed US$ 11.5 billion to reduce the trade deficit such that a significant balance of payments surplus is achieved. Furthermore, industrial growth is likely to require higher imports of raw materials and oil imports are likely to rise. Therefore, a reduction in imports of less productive goods is also needed to improve the trade balance.
Economic growth
This year’s growth has already been affected adversely by the drought in the early part of the year that affected cultivation and reduced the hydropower generation drastically. Even though the drought affected agricultural output and power generation, the change in weather has made its impact less than originally feared. The monsoon has arrived and agriculture is likely to pick up. The increased hydro electricity generation from now on is likely to mitigate the adverse impact in the early months to some extent.
The current improvement in exports is encouraging as it would lead to growth in the industrial sector. Industrial growth through higher exports could sustain economic growth. Expanding export markets that ensure growth in manufactures is vital for long term growth of the economy. Future economic growth depends on growth in manufactured exports, increased exports of services, especially information technology, efficient import substitution and increased foreign exchange earnings from tourism that would increase output of goods and services.
The most likely setback could come from oil prices that have been rising recently owing to the US and European confrontation with Russia over Ukraine. There is much uncertainty in global economic developments owing to this and economic sanctions. Economic implications of the Geneva resolution for the Sri Lankan economy remain uncertain though direct economic sections are unlikely this year.
Concluding reflections
The improvement in the trade balance and external finances should not lead to complacency in improving macroeconomic fundamentals that remain weak. While the economy’s growth rate is good, fundamental economic weaknesses threaten the long term viability of the economy. Although export earnings are rising, the servicing costs of the increasing foreign debt is straining the external finances. These are among the fundamental weaknesses of the economy that require to be addressed. Furthermore economic policies that encourage domestic and foreign investment and increase investment in education and health are vital for achieving higher economic growth in the long run.
The growth in manufactured exports could lead to reduction of the trade deficit this year to less than US$ 7 billion, provided there are no reversals in the growing demand from western economies and the country remains competitive in these markets. Improvements in exports and higher economic growth provide space for addressing the macroeconomic weaknesses in the economy. However as it often happens such opportunities are wasted by further borrowing and wasteful expenditure rather than the strengthening of the public finances, decreasing debt and spending on important area for sustained economic and social development.