The Sunday Times Economic Analysis

The Sunday Times Economic Analysis By the Economist

Inhospitable global developments and economic growth
The projected economic growth of over 5 per cent for this year is difficult to achieve. This, in spite of a high growth rate of 6.2 per cent for the first quarter of the year. Several factors are likely to impede the predicted economic growth of 5 to 5.5 per cent for the year. The oil price hike, a possible slowing down of the global economy and the uncertainty in the furtherance of the peace process are the main impediments.

The instability of the government, the contradictory approaches to economic policies that are being announced by the government and the economic fall-out of the strains on the peace process are also unhelpful to a healthy growth. Therefore to project the growth in the first four months of the year to the rest of the year could be misleading. Hard times are ahead.

The oil price hike has a multiplicity of adverse impacts on the economy. The government was certainly attempting to do the impossible task of shielding the economy from the higher oil prices. Consumers are meanwhile feeling the pinch of increased prices of domestically produced goods and the effect of the rupee depreciation. The increase in domestic food prices is due to lower production. If the rise in oil prices are passed on, this will not only affect prices directly, but also through the impact on transport costs. Were this to happen the projected inflation rate is likely to exceed even the new projection of 9 per cent by the Central Bank.

Therefore the policy of containing inflation through subsidisation may have a strong logic, as often times the rise in oil prices tends to be an occasion for other prices to skyrocket too and the spiralling of inflation is difficult to control. Nevertheless, the country is imposing on itself significant fiscal and balance of payments problems.

By not passing the higher oil prices to the consumer of oil products and electricity, it is accumulating a large fiscal burden. Besides, this policy is not helping to curtail domestic demand of either electricity or diesel and petrol. The attempt to find credit arrangements for oil purchases from suppliers or their countries could cushion the balance of payments for a while, but the accumulated liabilities would hit the external finances at some later time. Their impacts on the state of public finances are only a matter of time.

The current uncertainty in the peace process going forward is a significant problem for the economy. The expected aid for reconstruction of the North and East will hardly materialise during the rest of the year and may be never. Business and foreign investor confidence is being gradually eroded. Fortunately the attitude of the government and the LTTE to maintain the ceasefire despite some violations of the agreement and terrorist acts are keeping the situation in a state of restricted damage.

In the current context of negotiations, the realistic expectation can only be that of the ceasefire being maintained and of civilian life remaining little affected in the manner we have come to be accustomed after the ceasefire agreement was signed. This would ensure a minimum of disruption in economic activities. Tourism in particular has benefited from this environment of security. And so too agricultural production and fishing in the North and East. It is at least this precarious peace that we can hope would be maintained.

Currently there is no evidence of a slowing down in the global economy, but there is an expectation that if oil prices continue to remain as high as it is at present, that a global recession is inevitable. Although our industrial exports have grown there is some evidence that it has become tardy in the last couple of months. While industrial exports would be badly affected by the rise in oil prices, there would be some advantages for rubber and tea prices. But these are unlikely to be adequate compensation for the overall adverse impact of the oil price rise.

In such a situation a more unified approach to economic issues could be helpful. Then the government would be in a better position to respond to the harsh global situation. This we cannot expect owing to a preoccupation with the political repercussions on the one hand, and the different perspectives on economic policy issues by constituent elements of the UPFA coalition on the other.

This affects not only the current economic situation but damages economic growth in the next few years as well. The instability of the government only makes the economic predicament more precarious.

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