The Sunday Times Economic Analysis

The Sunday Times Economic Analysis By the Economist

The post-election economic hardships
Higher inflation inevitable
The economic consequences of the Presidential election could be unbearable. The country's economic problems are being swept under the carpet. Once the election is over they would rebound in much severe proportions. Difficult decisions are never taken at election time. When the economic difficulties are severe the postponement of correct decisions aggravates the problems for the future. An economic tsunami is inevitable after the election, but that is hardly the nation's concern now when we are preoccupied with elections. The promises are of a period of prosperity: a dream world of high economic growth, higher welfare benefits, lower prices, reduction of poverty and the generation of employment opportunities. No talk of hard times, of blood sweat and tears.

Economic problems are being aggravated by the inability to take the correct decisions. This is especially so with respect to oil prices.
Hard times are in store in the future when the impact of the oil prices will hit us hard. International oil prices have been climbing up, but there are no adjustments in domestic consumer prices. We are living in a world removed from the realities of the international market place. When the price of a barrel of oil rose to over US $ 70, the Chairman of the Petroleum Corporation held a news conference to say that the oil price hike in the American market had no effect on the cost of oil for Sri Lanka, as we get our supplies from the Middle East. Is this owing to ignorance of the international oil market and of basic economics or could there be another reason behind this announcement? Is it the politics of the current situation?

It is certainly true that petroleum and electricity prices would not be increased till the election is over. The reasons for this are not economic, but political. It is not because international prices are not rising, but the government is absorbing the increase in costs. This policy of not passing on oil price increases to the consumer has several dangerous economic consequences that the business community, other commentators and the Central Bank have pointed out. The subsidised price means that there is no adjustment of demand to the rising prices. Therefore no effort at conservation is likely. Expenditure on oil products, electricity and other related costs would be higher than international prices warrant. The static domestic consumer prices in a rising international price market means that domestic consumption would increase and the government would have to bear higher costs of the subsidy.

This would increase the budget deficit, increase the public debt and ultimately push all prices up because of the inflationary impact of the deficit. That is not all. The policy would have a damaging effect on the balance of payments, as the country would be importing more oil than the international price warrants. In 2004 the country spent 21 per cent of its import earnings on oil. This year it would be higher. The large trade deficit is likely to expand further. Yet paradoxically it is not creating a balance of payments problem owing to the inflow of Tsunami aid. Yet the strain on the balance of payments is latent and would come to roost sooner or later. Sometime in the future there would be an outflow of funds to meet expenditure of reconstruction that need imports. Sri Lanka has a fairly high import ratio in general consumption and the funds expended on reconstruction are likely to have a higher import coefficient.

The reality of the international oil price situation is that owing to the dwindling international supplies of oil the increasing price trend would continue. In fact some developed countries that have financial resources may buttress this rising trend by buying oil now at lower prices than at higher prices later.

In any event the trend of rising prices for oil is here to stay.
There could be fluctuations within this configuration of increasing prices, but a temporary dip in prices must not lead to a false sense of complacency. It would be foolish to interpret any temporary price decline as a sign of lower prices. The OECD has warned that higher oil prices are in store. The country has to adjust itself to cope with the higher prices. Subsidisation of oil and electricity prices only aggravates the problem and generates higher trade deficits and fiscal problems.

There can be little doubt that whoever wins the Presidential election would have to come to grips with this endemic problem of increasing oil costs. The fiscal problem that has been already created by the subsidisation of oil and electricity prices would have severe ramifications on the economy. Higher prices all round are inevitable. It would be hard times after the elections.

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