ISSN: 1391 - 0531
Sunday, February 18, 2007
Vol. 41 - No 38
Columns - The Sunday Times Economic Analysis

Dark clouds with silver linings

Optimistic expectations to calm hard economic realities

By the Economist

In the economic bind that the country has got into there appears to be a few silver linings. We may therefore indulge in some optimistic expectations. If these were to materialise, the short-term hardships would be abated somewhat and the long-run development of the country more on course. If these expectations are not realised, then the downturn of the economy and increased burdens on the people would be inevitable. Some of these expectations are based on the country’s own policies; others are entirely in the domain of international developments over which we have no control.

The first and foremost hope and expectation is that peace would be secured or at a minimum the hostilities would be contained. The most optimistic expectation would be that the year would witness not merely an end to the war but a constitutional and political settlement that would ensure a durable peace. In the context of historical prevarications of the past the settlement of the ethnic issue is optimistic. Nevertheless the incontrovertible fact is that such a settlement would bring huge economic benefits. Although peace would bring with it enormous benefits, the challenges of peace itself for economic and social reconstruction would be formidable. However moving from the tragedies of war to the positives of peace is qualitatively different for our political economy in the long term.

At the minimalist level, if the hostilities are contained and war expenditure reduced from those incurred in 2006, then this in itself would bring relief to the trade balance and the balance of payments. The fiscal stresses would be relieved to some extent and the government’s need to borrow domestically and in international financial markets would be reduced.

All this means an abatement of the spiralling inflation and reduced pressure on the rupee. Even such a minimum relief would be a respite to a large proportion of the population. The hopeful expectation is that most of the huge expenditure on military hardware has been incurred and that there would be a minimum of such commitment this year. The downside may however be that there are orders in the pipeline and that even some of the military purchases in 2006 may have to be settled this year. Last year’s trade deficit that is likely to be in the region of US $ 3 500 million may not be reflecting the full costs of military expenditure. This means that irrespective of whether new purchases are made or not there may be contingent liabilities from last year’s purchases.

However if the war is brought to a close then the country could live in the expectation that a further massive military expenditure would not continue to taint the trade balance and balance of payments in the coming years. The IMF has already warned that the country’s foreign exchange reserves have reached a dangerous level. IMF relief to the balance of payments would no doubt come with conditions that would impose further burdens on the people through a further devaluation or depreciation of the currency. Therefore we must hope for an end to hostilities to at least ensure no further burdens.

The other hopeful expectation is that international oil prices would not rise again. Currently there is a dip in oil prices that is a relief to the balance of payments. The optimistic expectation we could have is that the current level of prices would remain and that the country would be able to purchase the requirements for 2007 at these prices.

In which case the oil bill will be more in line with the costs of 2005 than the increased cost in 2006. Part of the realisation of this benefit is dependent on domestic petroleum product consumption not increasing due to a downward readjustment of domestic prices of petroleum and petroleum-based products.

Whether hedging that has been mooted as a means to reduce cost of oil purchases would confer a benefit or not is as difficult to predict as to whether the Petroleum Corporation Chairman’s selection of the cricket squad for the World Cup would bring the hoped-for results in March.

We must hope that the international prices of other imports would also not rise. This may be particularly optimistic as international commodity prices have increased recently. This is so with respect to sugar and wheat flour both of which are significant imports. Prices of petroleum-based industrial imports have also been increasing in the last few years.

We could hope that the decline in oil prices would reduce these import prices that would assist competitiveness of most of our industrial exports. However the overall balance of payments would be a key factor as a further depreciation of the currency could offset the advantage of reduced international prices to local importers.

In the gloomy economic situation that the country is in, despite the denial of it by the government and official agencies, we could hope for better times by reduced war expenditure by the ending of the war and a political and constitutional settlement that would usher a durable peace. This far more than any other factor is likely to bring an upturn in the economy. If international economic developments, especially oil prices were to remain relatively low by recent price levels, then this could be a further boost to the economy.

There is however no doubt that the vital ingredient for reducing the burdens on the poor and for a fast track economic growth is the illusive peace. We must live in the expectation that the government would propose an acceptable political settlement that the minorities would accept and one that would discredit the LTTE, irrespective of whether they come to the conference table or not.

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