The Sunday Times Economic Analysis

The Sunday Times Economic Analysis By the Economist

Is the economy resilient in the face of the oil crisis?
Engrossed as we have been on the budgetary figures and its assessments, we have nearly forgotten the current performance of the economy. The Finance Minister made the point that the economy was faring well and that economic growth would be a respectable 6 per cent despite the oil price hike. He quoted figures of industrial growth, increase in tourism, investment flows and export growth to buttress his case. Is his assessment fair and accurate? Is the economy strong? Is our only problem the rise in oil prices? Is the Sri Lankan economy resilient in the face of the oil price crisis?

The economic statistics for the first 9 or 10 months that are available do vindicate his position to a fair extent. Industrial growth has been in the region of 8 percent with industrial exports growing at 12 per cent. Overall export growth has been 11.7 per cent with agricultural exports growing by 9.8 per cent. However the export growth figures must be treated with discretion.

They reflect to an extent the increase in prices of imported goods owing to the oil price rise. In fact part of the growth is due to the rise in prices of exports owing to the higher price level induced by increased oil prices. The comparison between the increase in the export volume index and the export price index makes this clear. Further, owing to import expenditure rising rapidly, the trade balance has been a huge deficit of US $ 1704 million in the first ten months of the year.

Yet foreign exchange reserves have fallen by only 4.6 percent to US$ 3070 million owing to inward remittances, tourist earnings and investment inflows. However, official reserves had fallen much more by 17 per cent in the ten months of this year. At the end of October they were US$ 1929 million compared to US 2329 million at the end of 2003. Overall reserves have not fallen as much. The Central Bank estimates the reserves to be adequate to finance 4.8 months of imports. Inward remittances have increased to US 1242 million in comparison with US$ 1186 million for the first ten months of last year. Tourist arrivals have been increasing around 12 per cent with earnings from tourism rising at around the same rate.

Tourist earnings have increased to reach US$ 308 million at the end of October this year. If the trend of the first ten months continue, it is likely that tourist arrivals for the year would increase from 435,000 at the end of October to exceed 500,000 at the end of the year and be the highest ever.

There are however some areas of concern. These are in public finances and the balance of payments. In the case of public finances, the revenue shortfall could be significant.

The revenue collection for 2004 is likely to fall below the expected budgeted figure, while government expenditure may rise sharply. In which case the budget deficit in 2004 is likely to be higher than anticipated. If the growth in the deficit were larger than the GDP growth, then the public debt as a percentage of GDP would also rise to about 107 per cent of GDP.

This large debt is a serious cost to the public purse and distorts the public expenditure pattern, as well as future debt servicing costs. It is the objective of the 2005 Budget to bring down the deficit and reduce the debt: GDP ratio, but the mid term target of bringing it down to 85 per cent of GDP still appears unattainable.

As we have already noted the trade deficit has reached a huge US $ 1700 million. Fortunately the earnings from services and capital inflows are likely to reduce the deficit in the balance of payments.

The latent vulnerability of the economy is the issue of security. If the security situation worsens then tourism and investment flows would be adversely affected. In the context of a huge trade deficit this could be a serious situation.

What then is the verdict on the country's economic performance? Certainly the economy is not in crisis. The impression of it being in crisis mainly owes to the sharp increase in prices and the enormous difficulties that a large proportion of people are facing.

There is a fear that the price rises are gaining in momentum. It is incumbent on the government to find solutions to these fundamental problems. A modest growth from that of last year is inadequate to solve the problems that the economy faces.

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