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The certainty of receiving a currency swap of US$ 1.5 billion from the People’s Republic of China has boosted the country’s dwindling foreign reserves and enhanced its capacity for meeting this year’s large debt repayment obligations. There are however several uncertainties that could determine the state of the country’s external finances.

Foreign reserves

Foreign reserves that had fallen from US$ 4.8 billion at the end of January this year to US$ 4.6 billion at the end of February would rise to about US$ 6.1 billion.

This infusion of US$ 1.5 billion from the People’s Republic of China has not only increased the country’s foreign reserves, it has enhanced foreign confidence in the capacity of the country to meet the large foreign debt obligations this year.

The current foreign reserves are at a somewhat comfortable level. There is an expectation that this boost in confidence would enable the country to float further International Sovereign Bonds (ISBs) at more favourable   interest rates than otherwise.

IMF facility

However, the Chinese swap will not inspire as much international confidence as an International Monetary Fund (IMF) facility. An arrangement with the IMF would have been indicative of the country agreeing to principles of good financial management of the economy.

In fact, India insisted on Sri Lanka coming to an arrangement with the IMF as a condition for giving a similar swap arrangement.

Increase in debt

The downside of this currency swap would be to increase the country’s foreign debt and debt repayment. As pointed out in last Sunday’s column, it is only by increasing earnings from merchandise exports, exports of services and the strengthening of the balance of payments by workers’ remittances, earnings from tourism and foreign direct investment inflows that could really strengthen the reserves  and make foreign debt obligations less burdensome.

Increase in imports

An increase in imports is a certainty this year, despite the continuation, and perhaps, even further import restrictions. This is due to increased expenditure on fuel, fertiliser and raw material imports. There may also  be a need to increase food imports, if there is a shortfall in paddy and maize harvests due to climate related reasons.

Fuel prices

The prices of imports, especially fuel and fertiliser, are likely to be much higher this year. In January fuel import prices were US$ 57.65 per barrel, compared to an average annual price of about US$ 32 per barrel in 2020. Current prices are over US$ 60 per barrel and expected to rise further to over US$ 70 per barrel.

Import expenditure

Prices of fertiliser, raw materials and food are certain to rise. Increased expenditure on these imports at higher prices would increase import expenditure. All these factors considered, import expenditure is likely to increase beyond US$ 18 billion.

Increase exports

Is there a prospect of a more than commensurate increase in exports? Merchandise exports are expected to increase owing to a revival of global demand for the country’s apparel and rubber manufactures and the continued demand for personal protective equipment (PPE). A monthly average of merchandise exports of US$ 1.25 billion to reach US$ 15 billion in 2021 is achievable.

However, merchandise exports were less than US$  one billion (US$ 924 million) in January this year. Hopefully there would be an increase in exports in the subsequent months.

Threats

There are serious threats to the country’s exports, if economic sanctions are applied as a follow up of the UNHCR resolutions on human rights by countries that are vital for our exports. As emphasised in this space last Sunday, it is critically important to defuse such threats by diplomatic moves.

Uncertainties

There are several uncertainties and threats to the external finances this year. The extent to which exports could increase this year; whether the increase in workers’ remittance could be at current levels; whether tourist earnings would reach US$ 1.5 billion as targeted; and whether net capital flows would be positive or there would be only a small outflow of capital are uncertainties. The one certainty however is that import expenditure would increase to around US$ 18 billion or more.

Balance of payments

Trade deficits are endemic for Sri Lanka. There have been only about four of five years in the last seventy years when the country had a trade surplus. However, there are many years when the country had a balance of payments (BOP) surplus.

For instance, in 2019, in spite of a trade deficit of US$ eight billion, there was a BOP surplus of US$ 377 million.

Recent years

In recent years, balance of payments (BOP) surpluses were achieved owing to a large amount of workers’ remittances and significant earnings from tourism. This year too these two sources would be critical to achieving a BOP surplus.

Expectation

The government expects an increase in workers’ remittances and earnings from tourism this year. It expects workers’ remittances to exceed US$ 7 billion and tourist earnings to reach US$ 1.5 billion.

If these expectations are realised, the country will achieve a significant BOP surplus that would strengthen the foreign reserves and enable debt repayment obligations to be met comfortably.

Uncertain

Nevertheless, there is much uncertainty in realising these expectations, especially in respect of workers’ remittances.

With the onset of the covid19 pandemic and workers returning to the country, there was a dip in remittances. However, they picked up and last year’s remittances exceeded the previous years’ to reach US$ 7.1 billion.

There is considerable uncertainty that this increasing trend would continue. In fact, this bubble is likely to burst as workers remit their accumulated savings and return to the country.

Tourist earnings

The expectation of earnings from tourism to be US$ 1.5 billion this year is achievable, if there is a global control of the pandemic with the use of the vaccine and international travel and tourism recovers. An increase in tourists could be expected towards the end of the year and into the early months of next year.

In brief

In this context of increased import expenditure, increasing exports is vital to contain the trade deficit. If the Export Development Board (EDB) target of US$ 12 billion of merchandise exports is achieved, the trade deficit would be about US$ six billion.

However, a much higher level of merchandise exports is needed to improve the trade balance and balance of payments.

The possibility of increasing exports to over US$ 14 billion is needed to make a significant dent in the trade deficit to enable a much needed balance of payments surplus to strengthen foreign reserves.

Conclusion

Although imports are likely to increase significantly this year, there are prospects of increasing exports to offset it and achieve a small trade deficit. Increased earnings from ICT services and tourism could improve the balance of payments outcome.

However, the threat of trade  sanctions by several  important countries must be averted to achieve a favourable outcome in the balance of trade and balance of payments.

A continued global economic recovery and increased international trade and travel are prerequisites to improve Sri Lanka’s external finances. It is most important to ensure that trade sanctions are not imposed on the country’s exports.