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The only means of reducing the country’s foreign debt and external financial vulnerability is by generating a higher balance of payments surplus and minimising foreign borrowing.

Increased exports, higher earnings from services and much higher FDI are three of the crucial needs. A larger balance of payments would enable the repayment of debt and meeting debt servicing costs with the country’s external reserves rather than resort to further foreign borrowing.

At present there are no signs of achieving these. Only a stable government that pursues the needed policies could generate a much higher balance of payments surplus that could service the foreign debt comfortably. It is of utmost importance to increase exports in the next few years to reduce the large trade deficit. A steady inflow of workers’ remittances, increased tourist earnings, higher earnings from services such as ICT services and an increase in foreign direct investment (FDI) are also needed to improve the balance of payments.

Increase in foreign debt

As the balance of payments did not have an adequate surplus, governments resorted to further borrowing to meet debt and interest obligations. Consequently at the end of 2018 the foreign debt had reached US$ 54 billion and debt servicing obligations were in the region of US$ 4 to 5 billion annually.  A balance of payments surplus of more than US$ 5 billion is needed to make a dent in foreign debt.

The antecedents  

The foreign debt was only US$ 9 billion in 2000. It increased to US$ 11.3 billion in 2005, to US$ 21.4 billion in 2010 and to US$ 54 billion in 2018. This increasing foreign debt implied increasing debt servicing costs.

One reason for the escalation of debt is the foreign borrowing for repaying earlier incurred debt. There are several other reasons for this growth in foreign debt. They include the persistent fiscal and trade deficits and inadequate revenue for public expenditure.

Fiscal and trade deficits

Persistent fiscal and trade deficits have been responsible for foreign borrowing. Part of large fiscal deficits has been financed by foreign borrowing. Persistent trade deficits too have been an important factor contributing to the external indebtedness, as well as the difficulty in resolving it.

The country has had trade deficits in 63 of the last 68 years (1950- 2018). There were trade surpluses only in 5 of those years. The last time there was a trade surplus was in 1977 when there was a small trade surplus with stringent import controls and exchange restrictions.

Trade deficits have increased progressively and in fact ballooned in recent years. In the last three years it increased from US$ 8.9 billion in 2016, to US$ 9.6 billion in 2017 and to US$ 10.3 billion in 2018. Despite these large trade deficits, there have been balance of payments surpluses in some years owing to the trade deficit being off-set by workers’ remittances, earnings from tourism, earnings from other services and capital inflows.

However, large trade deficits have weakened the balance of payments and reduced balance of payments surpluses. Consequently, debt repayment has been with further foreign borrowing that has increased the foreign debt. Therefore the reduction of the trade deficit and improving the balance of payments are crucial to reduce the foreign debt.

Foreign borrowing

The inadequacy of domestic savings means that development expenditure has to be financed by foreign funds. Foreign borrowing is not intrinsically bad. On the contrary, foreign borrowing is an important means by which countries lacking in resources are able to develop. It is the means by which the savings-investment gap of a developing country is met.

However much of the   growth in our foreign debt was due to borrowing for the war and unproductive or low productive projects and consumption expenditure. The foreign expenditure did not result in an increase in tradable goods that would assist in the repayment of debt. These expenditures included large defence expenditure, development of infrastructure, such as expressways and roads, bridges, airport, harbours and sports stadiums.

Some of these expenditures are economically justifiable or essential, as in the case of defence expenditure and improvement of highways. However the expenditure incurred were much higher than they would have been had transparent international bids were called. Consequently the foreign debt incurred on these investments was higher than warranted. Some of the large foreign funded projects, far from resulting in foreign earnings, required further expenditure. This manner of foreign borrowing is a root cause for the country’s difficulty in debt repayment.

Infrastructure

Even large infrastructure investments that are needed for economic development of the country have a long gestation period and yield returns over a long period of time. Large infrastructure investments that have an economic impact but do not result in an increase in foreign earnings, become a burden on the balance of payments. In other words, even when infrastructure investment is fully justified, excessive expenditure on such projects could be a strain on the external finances as infrastructure has a long gestation period and would be inflationary.

Trade and balance of payments

All things considered the country’s external vulnerability can be mitigated only by a large balance of payments surplus. Although there has been an improvement in the trade balance in the first 9 months of the year, it is inadequate to generate a large surplus in the balance of payments this year.

In the first 9 months of this year, the trade deficit declined to US$ 5.61 billion compared to a deficit of US$ 7.95 billion in the same period last year. Therefore there is an expectation that the trade deficit would be US$ 8 billion or less in 2019. This could enable a balance of surplus of about US$ 3 billion or more if there are increases and in earnings from services and workers’ remittances.

The decrease in the trade deficit by US$ 2.3 billion in the first nine months of this year, compared to the same period last year, was achieved by a decrease in imports by as much as 13.4 percent and an export growth of only 1 percent. Although there has been a noteworthy export growth in the last two years, the export growth of only 1 percent in the first nine months is inadequate to make a significant improvement in the balance of payments.

A balance of payments surplus of about US$ 5 billion or more could be achieved only by a more impressive thrust in exports. This must be achieved by policies to improve exports, such as the reduction of para tariffs and the implementation of the Export Development Strategy.

Way forward

Reducing the weaknesses in the trade and balance of payments and enhancing the strengths in the trade and balance of payments is the way forward to reducing the country’s external vulnerability. The reduction of the large foreign debt is possible only with higher balance of payments surpluses that reduce the need for foreign debt repayment obligations.

The trade deficit must be contained by reducing unessential imports. Monetary and fiscal policy must ensure this. Exports must be enhanced by higher exports of tea and other agricultural exports and by an acceleration of the growth momentum in manufactured exports. Hopefully, tourist earnings will increase later this year and worker’s remittances will not drop.

Conclusion

Getting out of the foreign debt trap and reducing our external vulnerability is no easy task but a crucial one. Only a multipronged strategy could make an impact on reducing the country’s external financial vulnerability. It is only by generating a higher balance of payments surplus and minimising foreign borrowing that the foreign debt and external financial vulnerability could be mitigated.