Our front page headline story last Sunday warned of the impending balance of payments crisis that the country is heading to. The Central Bank of Sri Lanka has issued a communiqué stating that the country is not facing such a crisis and there was no need to devalue the Rupee. In denying such a crisis situation in the foreign exchange reserve position, the Central Bank stated that the current foreign exchange situation was not comparable to that in 1977 or even at the end of 2004. Perhaps more important was the statement that the Central Bank would not devalue the currency and the country would not turn to the IMF for a rescue package.The Central Bank statement said “current levels of Gross Official Reserves are well above the levels that prevailed before 1977 and in fact the reserves are even above the levels as at end 2004. Gross Official Reserves including ACU balances stood at US $ 2560.5 million as at end 2008 compared to US $ 2195.8 million at end 2004.” Comparisons of this nature between different time periods, when the real value of the reserves could be quite different, are not very helpful in understanding the state of the country’s external reserves.
The statement on the external trade position of the Central Bank in respect to the reserve position at the end of November 2008 asserted that the reserve position with and without the Asian Clearing Union reserves were US $ 2,608 million and US $ 2,030 million respectively, which were sufficient to finance around 2.2 and 1.7 months of imports, respectively. The position at the end of December 2008 was not much different to this. The reserves were adequate to finance around 2 months of imports.
This is not a comfortable level of reserves though perhaps adequate to avert a crisis. In actual fact how the trade balance behaves in the coming months and the net inflow of capital would be the determining factors as to whether the country would face an external finance problem.
The Central Bank is without doubt averse to borrowing from the International Monetary Fund. Many economists would be of the view that in the event of a crisis a bail out package from the IMF would be more certain, less costly and in the economic interests of the country. However the government is unlikely to opt for one as it would not want to comply with the attached conditions especially in respect to fiscal discipline and the management of the external value of the rupee.
The Central Bank says it has already taken measures to strengthen the reserves. These are arrangements of currency swaps with some central banks, promotion of investments in Treasury bills and bonds among the Sri Lankan diaspora and incentives for new depositors in NRFC and RFC accounts. With effect from February 1 2009, the Central Bank proposes the payment of a 20 percent bonus interest on NRFC and RFC deposits as a special incentive to encourage higher levels of inflows into NRFC and RFC accounts and the introduction of a once-and-for-all concessional final income tax for new foreign exchange inflows, if such inflows are liable to income tax.
The effectiveness of these measures to raise foreign exchange is to be seen in the coming months. They do however indicate fundamental weaknesses of an economy dependent on the diaspora, foreign Central Banks and foreign investors. What if these measures fail? If the problem is severe we may have to depreciate the rupee, but this too will be looked upon as a problem as it would have an impact on inflation. We may need to curb imports but stringent import controls would be difficult to impose in the current context and will not affect the really important imports. Then will we turn to the IMF to save the economy?
The crisis in foreign reserves could be averted if there is a significant decline in import expenditure. A substantial decline in oil prices to the level prevailing now will more than compensate for decreased prices for tea and rubber, and export earnings declining. Oil imports last year constituted about a fourth of the import bill. Therefore if oil prices decline, the trade deficit is likely to be much less than in 2008, even with depressed tea and rubber prices. This is about the best hope for the balance of trade and balance of payments in 2009. If oil and commodity prices decline, then there would be a significant decrease in the trade deficit. If this scenario does not work out, then the trade deficit would be a severe strain on the country’s reserve.
There is also anxiety in respect to capital inflows. In the recent past remittances from Sri Lankans have been a good support to the balance of payments. What is more, these remittances increased significantly, especially in the last two years. One of the important reasons for this continuing increase was the larger employment opportunities in oil producing countries. There are fears that these inflows would decline as there have been a sudden change in the economic fortunes of these countries with the decline in oil prices. For instance construction work in these countries has come to almost a standstill. What this downturn in the incomes of these countries and their reduced economic activity and less employment opportunities means for the Sri Lankan economy is, there is a strong prospect of remittances from Sri Lankan workers declining. In which event, worker remittances that financed about 40 percent of the trade deficit last year is likely to decline. Other capital inflows are also likely to decrease. In the global context of an economic and financial meltdown, foreign direct investments are not likely to increase. Portfolio investments are difficult to predict, but at present outflows are likely to be more than inflows. Foreign commercial borrowing is likely to be difficult and costly. Foreign aid has already dwindled.
Given these adverse possibilities it is vital that the trade deficit is brought down drastically to a near surplus level. Whether this could be achieved depends very much on the international prices of our main imports, petroleum, wheat, fertilizer, sugar, milk and other essential food imports. These are not within the control of the Sri Lankan government. What are within the control of the government are cuts in wasteful and unproductive expenditure to bring down the fiscal deficit and reduce inflationary pressures that would assist industry. |
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