The disquietingly growing trade deficit

The latest trade statistics for August confirmed the fears that the trade deficit would continue to grow and reach a huge proportion. In the first eight months of the year the trade gap had nearly doubled to what it was last year. Last year’s trade gap was in itself a record one of US$ 3560 million, higher than in the previous year when it was US$ 3371. In 2005 the trade deficit was much lower at US$ 2516. As these statistics indicate, the trend of increasing trade deficits is at an accelerating momentum. Already the trade deficit of US$ 4106 for the first eight months is 86 percent more than it was for the same period last year and has exceeded the deficit for the whole of last year. No doubt the trade gap threatens to reach a new record level of around US$ 6000 million.

Although there is some hope that the trade account would be eased by the decline in the oil price, there are other factors in the recession that are having adverse effects. Since the reduction of the oil price has been only in the last two months of the year, it will have only a marginal impact on the 2008 trade deficit. However if the prices of oil remain around US$ 65 a barrel, as it is at the time of writing, then next year’s oil import bill would be significantly lower and give considerable relief to next year’s trade balance and balance of payments. There are two considerations however in realising this expectation. First, we must keep the petroleum product consumption at around current levels. Any increase in consumption could negate the price decline and thereby the total outlay on oil imports would be high. Second, the expectation of the oil price not rising must be realised. The recent volatility in oil prices makes this expectation quite uncertain. This factor must be kept in mind in determining internal prices for petroleum products.

However, there are other disquieting developments connected with the global recession that are affecting the trade balance adversely. Tea prices are falling and the expected high income from tea exports would not materialise, though the total earnings for this year would be a record one owing to the high tea prices in the first three quarters. By the end of August tea export earnings had reached US$ 885 million, an increase of 42 percent over that of the same period last year. Nevertheless the tea industry is currently in crisis. Not only has the tea price dropped by around 25 percent of what it was recently, but the purchase of tea at the auctions has been sluggish. This is causing a severe strain in the financial chain up to the producers. Tea smallholders, who account for the bulk of tea production in the country, are facing severe difficulties in selling their green leaf. Tea estates too would be in a cash bind both immediately and in the future. The long term effect of the declining prices on tea would be a difficulty to match costs of production to the new prices in a context of inflation. The tea industry would have to accept tea prices at current levels rather that at the boom prices experienced recently.

Rubber prices too are likely to fall owing to the decrease in oil prices that would reduce the costs of production of petroleum-based synthetic rubber. The recession would also reduce the demand for many rubber-based goods like tyres, tubes and rubber gloves, among others. Consequently, natural rubber prices are likely to fall. This is an unfortunate development as the rubber producers were responding effectively to the increase in international prices. The bounce in the rubber industry that was seen after years of slumber might taper off. This is indeed an unfortunate development for the country and could have repercussions on the long term development of rubber growing.

Above all, there is clear evidence that industrial exports would also not increase. In fact they have been performing poorly in recent months. The signs of flagging industrial exports were seen early this year. Industrialists, economists and commercial interests had drawn attention to the danger signs. The macro economic environment was becoming less favourable to industry. Most significantly, the high rate of inflation was affecting the costs of production and threatening the profitability of key industries. The competitiveness of industrial products in international markets was being eroded. Yet this was not heeded to as if it did not matter or that other favourable factors in the trade account such as the higher earnings from tea and rubber would offset the decrease in industrial export earnings. The reasons for the rise in agricultural exports should not have been any comfort for the decline in industrial exports as the reasons were as different as chalk and cheese. In the event industrial exports grew by only 7.6 percent in the first seven months with garments, the main industrial export of the country accounting for about two thirds of industrial exports, growing by only 5 percent.

Besides these adverse developments in the trade account, income from services and capital inflows could also lessen in the coming months. The tourist industry is battling a serious fight to get more tourists in a security context that is not at all conducive to an increase in tourism. With little prospect of the security situation improving, the global recession is compounding the problem. The increase in air fares, the depreciation of several countries from which tourists come to the Island, the lower expendable incomes on travel and the reduction in the net wealth of people in several countries, are serious blows to tourist earnings.

Remittances from abroad could be adversely affected by the recession. There are fears that remittances from abroad would decline. This is based on the view that the reduction in incomes of oil exporting countries that boomed in recent months would decrease. Also since remittances also come from other countries that are affected by the global recession, there may be some decrease in remittances. It is more likely that the growth in remittances would decelerate than see a decline in the amount of such remittances.

The vulnerability of the Sri Lankan economy to global developments is once again being demonstrated in the current global economic crisis. We can only hope that the oil price decrease will stay on and that the benefit of the decrease in oil prices would more than off-set the decreased earnings from exports. The most serious of the adverse trends lies in the slow growth in industrial exports. Timely action to ensure an economic environment conducive to industrial exports is imperative.