The considerable improvement in the external reserves should in the current conditions make us adapt the famous Parakrama Bahu the wise, saying: “Do not let a single drop of foreign exchange that comes into the country flow back without it being used wisely for the country’s good.” The large foreign exchange reserves are an opportunity for investment, not for unproductive use and consumption.
Although the country’s external finances have improved considerably, this improvement must be looked at with a cautious optimism rather than unbridled jubilation. For one, a significant improvement in external reserves has been from borrowing or investments that are transitory. As much as we have received these funds, they may be taken away at short notice. Much of the foreign reserves are contingent liabilities not earnings. This does not mean they are not useful. They can be utilised for the country’s advantage with prudent and wise management of investment and public expenditure. They however could also be frittered away to create a huge burden to the economy and lead it to a crisis situation.
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The second aspect is that there are vulnerabilities in our external finances. The trade balance that is persistently in deficit will show an improvement this year owing to import prices being much less than last year for about three fourths of the year. Yet it remains in deficit, and this deficit could widen if import prices rise sharply. It is very significant to note that there are signs of oil prices increasing and consequently the trade deficit worsening in the next few months and more important, in the next year.
The import side of the trade equation could turn unfavourable owing to oil prices rising and import costs increasing.On the export side, the country has fared badly so far with export earnings declining by 19 per cent in the first seven months of this year. There are signs that this would continue into the next five months as well. In fact the signs for next year are not good at all. Apart from this declining trend, the likely withdrawal of the GSP Plus status in European countries is a serious blow to the country’s industrial exports. Again the impact of this would be felt next year. The combination of these factors do not portend well for the economy in the coming months. It is therefore very important that we press the advantage of the large reserves for the benefit of the country.
The country’s external reserves are continuing to rise. It has now reached over US$ 4.5 billion. With the sovereign bond issue of US$ 500 million the reserves would rise to over 5 billion dollars. This is a more than comfortable level of reserves, even adequate to meet another external shock by way of a rise in petroleum and commodity price increases or a fall in export earnings or both. In fact the prospects of both these are lurking in the background. Yet quite apart from the balance of payments position it strengthens, the resources must be utilised to strengthen the economy, especially its export capacity and competitiveness.
In an interview with Reuters the Central Bank Governor Ajith Nivard Cabraal has said that the Central bank was aiming at a comfortable level of reserves. He told Reuters: "We are at present with $4.5 billion reserves, but we want to ensure that we come to a certain position that gives us confidence to meet any challenge thereafter." He did not specify what that “certain position” would be. We can perhaps conjecture that once the reserves reach over US$ 5 billion the Bank would consider it adequate to meet “any challenges thereafter”. It is not clear what these challenges are. Are they what we have indicated here of falling export earnings and increasing import expenditure or some other factors in the mind of the governor?
There is a definite possibility that petroleum prices are again on an uptrend. Last week oil prices rose above $75 a barrel. This is a record high for the year. It is generally attributed to a global economic optimism that expects a recovery in global energy demand. Oil rose above $75 a barrel to settle at a record high for the year last week, as global economic optimism hinted at a recovery in global energy demand. The two main factors for the increasing oil demand is the expected global economic recovery owing to increased demand for oil owing to the stabilization in U.S. demand and strong growth in Chinese demand. Additionally there is the usual seasonal factor of winter setting in that increases the demand for oil. Therefore the oil bill during the rest of this year could be expected to increase. Oil prices have more than doubled from below $33 in December owing to these expectations. An increase in oil prices of that magnitude will increase the trade deficit in the next few months. However most of the impact would be in 2010. We can only hope that oil prices would not increase next year to the peak levels of 2008.
The problem of the continuing trade deficit is compounded by a decline in exports. Export earnings declined by 19 per cent during the first seven months of this year. Agricultural, Industrial and Mineral exports declined this year. The largest decline was in agricultural exports by 19 per cent, while the most significant decline in exports was in industrial exports by 18 per cent. All three main agricultural exports—tea rubber and coconut—declined, as was the case with industrial exports.
The only silver lining in the dark clouds is that the decline in garment exports, the single most important export item, was of a lower extent being only 6.8 per cent. This weakness in our exports can get worse if the country loses its GSP Plus status. Europe is a most significant market for the country’s garment exports and the loss of this status means that the country’s competitiveness would be severely affected. However this too would take effect only next year.
The large foreign exchange reserves that have been amassed should not lead us to an unwarranted euphoria that in turn leads to reckless spending. Most of these funds are contingent funds that can move away in the fullness of time. There is a likelihood that the trade deficit could balloon once again owing to increased prices of imports and a poor performance of exports. It is therefore vital that wise counsel prevail to ensure that this advantage and opportunity is not frittered away. |
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