The Sunday Times Economic Analysis

The Sunday Times Economic Analysis By the Economist

The tsunami anaesthesia could be deadly
The memories of last year's economic performance have been virtually swept away by the tsunami at the tail end of the year. In fact some have described the tsunami with the utterly insensitive saying that it was " a blessing in disguise". May be it was for the government that was confronting severe difficulties owing to the oil price increases.

The oil price hike was creating serious economic and political problems by increasing domestic prices, draining foreign exchange reserves and necessitating the consequent depreciation of the rupee, which was in turn fuelling inflation. The pricing policy adopted by the government for petroleum and electricity was also leading to financial problems for these corporations and in the fullness of time for the government. The end year position was one of higher inflation as well as a higher level of unemployment. These and other issues would no doubt be brought out again when the Central Bank's Annual Report for 2004 is released end April. Even then the economic concerns would be in muted tones with the central theme being probably the economic growth rate of about 5 per cent despite the oil price shock. One would have to read between the lines to find the fundamental problems.

We have to await the Central Bank's Annual Report for the final and precise figures for last year. Meanwhile there is sufficient data to remind us that last year witnessed some serious economic difficulties that had an effect on the fundamentals of the economy. Much of it was doubtless caused by the steep rise in oil prices. The trade balance leapt to a massive deficit of US $ 1947 by end November indicating it would have exceeded US$ 2000 million by the end of the year. Official reserves dipped nearly 20 per cent from US$ 2329 million at the end of last year to US$ 1872 million by the end of November.

Private reserves however fell only about 3 per cent from the end of last year to end of November. Consequently the pressure on the rupee, perhaps aided by some intelligent speculation, saw the depreciation of the rupee to over Rs. 104 towards the end of the year despite a weakening of the US $ itself on world currency markets. The depreciation of the Rupee with respect to other currencies, notably the UK Pound Sterling and the Euro was much higher. This had the effect of increasing import prices of essential items sharply. Domestic prices too rose on the strength of this wave of import price increases and a shortfall in domestic production of food crops.

The rise in oil prices was impacting very directly on the price of petroleum, gas, kerosene and electricity. Even though the continuous announcements of price increases were loathsome to consumers and virtually crippling the poor, they did not reflect the full increase in international fuel prices. Consequently the Petroleum Corporation and the Ceylon.

Electricity Board notched up losses and debts to banks. Sooner or later these have to be liquidated and the burdens passed on to consumers.

It is in this economic background that the tsunami struck us at the tail end of the year. The economic data for 2004 was unaffected, but these serious problems were forgotten by the enormity of the disaster. The flow of aid including the IMF's gesture to waive off the capital and debt servicing payments, resumption of promised assistance withheld owing to the government not complying with the required conditions, several countries deciding to waive off the interest payments on their debt contributed to an euphoria far from the economic and financial realities. For a government groping for a solution to its problems the new wave of aid was the needed anaesthesia for itself and to be given to the people.

The opposition parties waiting in the wings to capitalise on the deteriorating economic conditions suddenly found the ball in their hands suddenly taken away. The fundamental problems of the economy have not been resolved. They may be hidden for a while but their reappearance is inevitable as the euphoria fades away. Not even the large doses of foreign aid would solve those fundamental problems, especially as they are for resettlement, reviving, rebuilding, reconstructing and rehabilitating the devastated areas. Their impact on the generation of additional goods and services are still distant. The advantage of aid is temporary.

Some of the aid would require to be repaid. Democratic governments in the developing world are often short-term in their perspective with only the next election in mind. Sri Lankan governments have been even more so. To them the tsunami is a "blessing in disguise". For the people at large the long-term impact could be a setback to the resolution of their problems unless the economy is managed with a long-term perspective.

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