The Sunday Times Economic Analysis

The Sunday Times Economic Analysis By the Economist

A balance of payments surplus amidst a huge trade deficit
The Central Bank expects a balance of payment surplus of around US$ 200 million. This is despite a huge trade deficit, possibly exceeding last year's massive deficit of US $ 2.2 billion. This appears to be good news. Yet if taken at its surface value this could lead to complacency and problems in the future.

The trade deficit of over US$ 2 billion is expected to be offset by services income, remittances from abroad, capital inflows in the form of aid, loans and foreign investment. The balance of payments has also been supported by differed payments on oil and moratoria on debt repayment. All these have created a situation of comfort on the balance of payments despite the mounting trade deficit.

This is certainly a comforting picture in as far as this year is concerned and perhaps even for the next year. Yet it is the backdrop for an evolving crisis in the balance of payments. Economists have pointed this out. The Secretary to the Treasury, Dr. P.B.Jayasundera has himself urged the adoption of economic policies and energy development measures to reduce oil imports, whose rising costs have been mainly responsible for this large trade deficit. Enhanced power generation from non-thermal sources is a long run solution that is needed. Yet such solutions take time and the crisis is already with us.

There is an extraordinary insensitivity to the oil crisis in the country. No doubt this is partly due to the prices of petroleum products not being sufficiently aligned to the rising prices.

There may have been a slight reduction in consumption, but this is indeed small and inadequate in comparison with the magnitude of the problem. Besides this there is an unrealistic hope and expectation that the oil price hike is a temporary one and that prices on the international market would come down. The fluctuations in prices that have been witnessed are being misinterpreted to generate an expectation that oil prices may fall. In fact the supply and demand situation for oil globally is such that oil prices are on an inevitable rising trend.

Therefore it is essential that the country adopt immediate solutions to cope with the problem both in the short run and for the long run. The current electoral politics is not at all conducive to such policy making. It is even unlikely that the correct policies for both conservation and generation of energy in the future would be taken after the elections owing to the plethora of rash promises being made at the elections.

The balance of payments surplus this year should not lead to complacency. It has been brought about by exogenous factors. Many of these are temporary and are contingent liabilities for the future. Some of the capital inflows will sooner or later be outflows of capital. For instance, some of the capital inflows such as tsunami aid when utilised would have a large element of imports. The capital inflows such as portfolio investment could very easily flow out due to favourable, as well as unfavourable conditions, as the investors’ intent is to maximise short-term gains on the market.

A perception that the market would fall too could lead to large scale selling, while a rise in the market could also lead to capturing the gains and quitting the bourse. Both these are likely scenarios. The current political instability is conducive to possibilities of capital out flows. The deferment of debt payments means an additional burden on the balance of payments in future years.

Deferred payments for oil imports and lines of negotiated credit means that the commitments would have a drain on reserves of the future. These are all factors that must restrain our contentment with the balance of payments surplus. We must view the BOP performance in a realistic manner and position our trade and financial policies accordingly. Deferring structural and policy adjustments is at the grave risk of accentuating our balance of payments problems. This is especially so as the country has in any case not had a trade surplus of even a small amount for the past 28 years.

We have to view the current balance of payments surplus in terms of the components by which it has been arrived at and realise its attributes to ensure that the future is not one of severe balance of payments difficulties. The improvement in the balance of payments should not lull the country into a complacency that would lead to adverse balance of payments situation in the near future. The fact is that the country has severe imbalances in its trade. These must be addressed soon.

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