The current balance of payments problem may be resolved by large sums of foreign funds for resettlement and reconstruction.
As we pointed out last week, there is a prospect of large sums of foreign funds for the resettlement of the internally displaced persons (IDPs) and for the reconstruction of the North and East. These would replenish foreign exchange reserves that could resolve the current balance of payments crisis. This happened in 2005. When the Tsunami struck the country in December 2004, the country was in a severe balance of payments crisis but the Tsunami funds altered the country’s external reserve position dramatically. In the year following the Tsunami the country registered a balance of payments surplus and had a comfortable foreign exchange position. In 2005 there was a trade deficit of US$ 2516 million but owing to the large sums for Tsunami relief the year ended with a balance of payments surplus of US$ 501 million. One of the worst disasters for the country turned out to be a blessing in disguise in as far as the balance of payments and the foreign exchange reserves were concerned.
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There is an expectation this year’s balance of payments would perform similarly. The country is awaiting a large amount of foreign aid for the rehabilitation of the internally displaced persons and reconstruction and rebuilding of the East and the North. Such an inflow of foreign assistance would replenish the country’s foreign exchange reserves that are at a critically low level. If there are large inflows of foreign aid, the country would have a comfortable reserve position once again.
This expectation of foreign assistance for reconstruction is related to the broader problem of the need to settle debts of as much a magnitude as the reserves. The trade deficit, on the other hand appears to be within the grasp of settlement through other capital inflows. Private remittances have offset the declining trade deficit to bring about a balance of payments surplus in the first quarter of the year. Although the aid flows are for the specific purposes of rehabilitation and reconstruction of affected people and places, where such aid is financial, they would initially boost the balance of payments, although after a short time a fair proportion of such financial flows would flow out to finance the import content of the rebuilding.
The relief expected from the IMF loan facility that has been excessively delayed still remains uncertain. If there are large inflows of foreign aid, in the context of the current nationalistic rhetoric of self-reliance it would not be surprising if the government even calls off the facility once there is sufficient evidence of aid flows from other sources. This is not necessarily a favourable development as the conditions placed by the IMF would be beneficial as it would entail fiscal discipline and better management of the country’s finances.
Sri Lanka is a foreign aid dependent country. This is not because of the quantum of aid the country receives each year, but the psychological dependence we often display in our statements about the obtaining of foreign aid. This was more so in years gone by when our ministers returned after their successful missions at the Aid Club or Aid Consortium with boasts of more aid that year than in the previous one. The rhetoric is more muted now as our aid dependency has also declined. In fact the amount of foreign aid we receive is not as much as the rhetoric would make us believe. The foreign aid in the form of grants is quite small. It is a small proportion in terms of other capital inflows. The aid flows in recent years have been a fraction of the financial inflows we receive as private remittances. Yet we are highly beholden to the donor community as saviours of the economy.
There is no doubt that the country’s resources are meagre and very inadequate to meet the expenditure of the rehabilitation and the reconstruction. We definitely need a massive amount of assistance for the task of rebuilding. The expectation of large inflows of funds for rehabilitation and reconstruction may be affected owing to the current economic recession in developed countries that are still grappling with their own problems and spending large sums of money to revive their own economies. Consequently their assistance may be limited.
The East-West divide that has occurred over human rights and civilian deaths in Sri Lanka could also be a factor in reducing aid from these countries. Fortunately Sri Lanka has other friendly countries from which they could receive substantial assistance. Most flows of foreign assistance may be from Asian countries such as China, India and Japan. Assistance is also expected from Libya, Iran, and Russia, Denmark and Saudi Arabia and other Middle Eastern countries. Britain Canada and the US have also indicated assistance.
There are many reasons why we must be cautious of this aid dependency. Much of the inflows would be in kind. Some of the inflows of capital would be used to import requirements that would result in their outflow as well. There would be a large import content in the rebuilding and reconstruction expenditure. Therefore much of the funds that come in would boost foreign exchange reserves temporarily but would flow out to finance needed and increased imports quite soon. Furthermore, the actual amount of foreign funds that would be made available would be much less than those promised, as was the case in the Tsunami aid. There is a history of countries pledging aid at times of disaster that never materialise. Pledges have to be transformed into commitments and these into disbursements. There are many slippages at each stage. Pledges and commitments do not always result in actual aid disbursements. The actual manner and levels of aid utilisation have an important bearing on the amount that would be ultimately disbursed. If there were evidence of mishandling of aid and corruption then donor countries and international agencies would withhold their commitments.
The country’s capacity of aid utilisation could also restrict the amount disbursed. Our experience of aid utilisation has been that only a fraction of the aid committed have been utilised. Most aid is time bound and if we are unable to utilise the commitments within a timeframe, then the aid disbursement could be a small fraction of the aid pledges and commitments. Aid fatigue is a well-known phenomenon. Often there are conditions attached to aid that cannot be fulfilled. These could include political conditions, such as the extent of political devolution, economic policy preconditions and aid utilisation requirements. These may not be apparent at this stage but would emerge, as the subsequent assistance is committed.
The amount of aid already pledged has been large and could go a long way in rebuilding the country’s devastated areas. Yet, as we pointed out earlier all the pledges that were made may not translate into actual commitments. There may be an element of exaggeration in the real value of the assistance and most of all we may not be able to utilise what is committed owing to our own limited absorptive capacity. However unlike in the case of other project aid, this emergency relief tends to be better utilised.
“Absorptive capacity” is a euphemism for organisational incompetence, inefficiency, corruption and other misdeeds. Nevertheless we have substantial amounts pledged that should be used to a maximum in a cost-effective, efficient and expeditious manner.
Even though the country’s balance of payments problem may be resolved by such aid, the fundamental problem of recurring trade deficits and large foreign debt servicing costs would remain. The temporary relief to the balance of payments and the meagre reserve position should not lead us to think that our fundamental economic imbalances are resolved. |
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