Oil and food price increases causing massive trade deficit

By the Economist

While soaring oil and food prices are at the core of the country’s inflation, its impact on the trade balance and the balance of payments is largely ignored. The widening trade deficit is now reaching an alarming proportion even though items in the capital account are saving the country from a balance of payments deficit. As in recent years we are likely to have a huge trade deficit but a balance of payments surplus. The continuous and progressively increasing trade deficits have not drawn much attention owing to the balance of payments surpluses that have been achieved in spite of the huge trade deficits.

Last year for example in the face of the massive trade deficit, the balance of payments was in surplus by US $ 531 million. This surplus was owing to the large amount of inward remittances, the considerable amount of foreign borrowing and capital inflows for portfolio and direct investment. This year too indications are that we would be able to record a balance of payments surplus. In fact the overall balance of payments is estimated to have been in surplus by US dollars 448 million by end-March 2008.

The trade deficit for the period January - February 2008 widened to US dollars 937 million, compared to the deficit of US dollars 447 million for the corresponding period last year. This doubling of the deficit is indeed ominous as the causes for the deficit, the prices of oil and of food imports, show no signs of tapering off. In the single month of February 2008 it was as much as US dollars 317 million compared to US dollars 147 million in February 2007. If this trend continues the trade deficit is likely to exceed US 5000 million.

While this large trade deficit has been brought about by the increase in import prices, it must also be remembered that the country has gained some advantages too from the oil price boom. Export earnings from rubber and tea have been the particular gainers. Rubber prices have boomed owing to the oil-based synthetic rubber prices rising sharply. International rubber prices have also increased because of the large increases in the demand for vehicles in China and India in particular and other prospering oil exporting countries. The demand for tea has increased owing to the higher incomes in oil exporting countries, mainly those in the Gulf and in Russia and Eastern Europe. Increased earnings from tea made a significant contribution to the growth in agricultural exports, with export prices of tea continuing to remain strong. Consequently the country’s agricultural exports grew by 35 per cent in the first two months of the year compared to the same period last year when there was a substantial increase in these agricultural exports for the same reasons. Increased agricultural export earnings made a significant contribution of 72 per cent to the increase of total export earnings. Agricultural exports account for nearly 25 per cent of total exports.

It is also likely that the increased worker remittances were partly due to increased demand for labour in the Middle East in particular. Worker remittances increased by around 23 per cent during the period January-February 2008 to US dollars 487 million. These increases in remittances were an important contribution to reducing the adverse impact of the oil and food price increases on the trade deficit. The remittances in the first two months of this year covered nearly one half of the trade deficit during the same period.

It is likely that this year’s trade deficit would be considerably larger than the record trade deficit of US $ 3560 million of last year. Last year’s trade deficit surpassed the previous huge trade deficit of US 3371 million in 2006. Last year’s massive trade deficit was in spite of an export growth of 12.5 per cent. On the basis of the export figures for the first few months and global conditions, it is likely that exports would not grow by as much as last year.

In the first two months of this year exports grew by 11.6 per cent owing to the slowing down of industrial exports. Industrial exports contributed only 18 per cent to the growth in exports in the first two months of this year as earnings from textiles and garments declined by 2.7 per cent. Cumulative earnings from exports during the two month period January - February 2008 was US dollars 1,198 million. The decline in garment exports is ominous as it is the country’s largest import item and has accounted for over 50 per cent of export earnings in recent years.

Progressively larger trade deficits have characterised the trade performance of recent years. As indicated earlier this year’s deficit is likely to be massive. The increases in exports continue to be unable to bridge the deficit as imports have grown by progressively higher amounts than exports. This is owing to import growth being higher than export growth. Last year’s export performance demonstrates this well. While Imports grew by US $ 1047 million, exports grew by only US $ 857 million. Consequently the trade deficit widened to a record level in 2007. Even though there is export growth, it is much lower than the increase in imports. The ever-increasing value of imports is mainly what causes the deficit in the trade balance.

Imports of both intermediate and investment goods imports increased significantly last year. In contrast, consumer imports declined by 9.5 per cent or 586 million US dollars. Although the high prices of consumer imports curtailed their imports, intermediate goods imports increased by as much as 9.5 per cent or US 586 million dollars. Capital or investments goods imports also rose by 19.3 per cent, but their import value was only US 439 million dollars. This year’s performance is likely to be similar though on a larger scale. However unlike last year when consumer imports were curtailed, this year’s large imports of rice in particular at high prices, as well as the increases in prices of other food items and of oil will cause a serious dent in the trade balance.

The indications are already there in the statistics disclosed by the Central Bank for the first two months of the year. Expenditure on imports during the first two months of 2008 amounted to US dollars 2,135 million. This is a 40. per cent increase and was caused by the expenditure on imports of consumer goods increasing by 40 per cent owing to sharp increases in the amount of imports of rice and wheat at high prices. The growth in expenditure on imports of intermediate goods during January-February 2008 recorded a growth of 44 per cent and imports of investment goods recorded a growth of 59.6 per cent. The latter is attributed to increases in imports of transport equipment, building materials, machinery and equipment.

The massive trade deficits of the last several years have not been a serious problem owing to the balance of payments surpluses that have been recorded. These balance of payments surpluses have been owing to increased foreign borrowing, increasing flow of remittances and other capital inflows. Economists disagree as to whether the offsetting of trade deficits by these means is good.

The remittances of countries are now recognised as a permanent feature of these countries and as equivalent to export incomes. Foreign borrowing is a different kettle of fish as these are contingent liabilities and unless these borrowings lead to an increase in tradable goods or services or reduces imports they would be a burden on the economy. It is however prudent to find ways and means of curtailing imports, especially of oil, vehicles and armaments.