The foreign exchange reserves of the country are high. The foreign remittances of Sri Lankan workers from abroad have wiped out the trade deficit to transform the current account in the balance of payments into a surplus in 2009. The very comfortable foreign exchange reserve of the country at over US$ 5 billion is undoubtedly a very favourable development. A further loan of US$ 300 million expected from Russia would boost reserves. These favourable developments in the external finances of the country could however result in complacency about addressing fundamental economic problems.
The trade deficit for last year has been reduced by over 50 percent compared to the huge deficit of 2008. This too is a favourable development, but one that could result in policy inaction to improve the country’s trade performance. Nevertheless the fact that it is considerably less than the massive trade deficit of 2008 is a favourable development. The most favourable development of all is the large inflow of workers’ remittances that have been increasing at the rate of 14 percent and are so substantial that remittances have more than offset the trade deficit to generate a current account surplus in 2009.
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Beneath these favourable developments in external finances there lurk possibilities for wrong directions in economic policy and serious economic vulnerabilities and concerns. The deficit in the trade account was off-set by the higher inflows of workers’ remittances. During the first eleven months of 2009 workers’ remittances increased by 14.2 per cent to US dollars 3,035 million which was much more than the trade deficit for the period. These remittances not merely offset the deficit but were about 25 per cent more than the trade deficit. Then why is this favourable outturn a matter of concern?
The concern in the trade performance is related to the manner in which the trade deficit was reduced. The decrease in the trade deficit last year was entirely due to the decrease in the import expenditure and not due to an improvement in export earnings. In fact export earnings declined by a significant 14.7 percent. What is more all categories of exports registered a decline. Agricultural exports declined 12.3 percent and industrial exports by 15.1 percent. Earnings from the country’s main agricultural export-tea-decreased by 10.2 percent. Agricultural exports are however showing signs of an improvement owing to increased production of tea and rubber and improved international prices as well. In this scenario of an unfavourable export performance, one can take a little consolation in the fact that the country’s main industrial export-textiles and garments- declined by only 5.3 percent.
The decrease in industrial exports by as much as 15 percent is disconcerting as it is of serious consequence to long term economic development of the country. This declining trend in industrial exports is a threat to the country’s industrial development, employment and incomes of the poor. Yet the seriousness of the problem tends to be underplayed when it does not lead to a deficit in the current account of the balance of payments. Consequently corrective action is not taken to ensure the competitiveness of industrial exports. This together with the fact that the country has a good foreign reserve position leads to a neglect of industry. Specifically when corrective measures are needed in exchange rate policy, there is no motivation to make the adjustment as the balance of payments and the foreign reserves are performing well. Policy makers must be aware that this complacency induced by a good reserve position and remittances from abroad is harmful to the country.
The very comfortable foreign exchange reserve of the country at over US$ 5 billion has serious negative implications. First of all it leads to an attitude that everything is fine in the economy and therefore the problems with respect to exports may not be addressed. The reserves would tend to make the exchange rate veer towards a higher than appropriate exchange rate. Consequently the nominal exchange rate, as well as the real effective exchange rate, may remain unrealistic and hurt export competitiveness. Since this is not easily appreciated in a favourable exchange reserve position, it could hurt export industries irreparably as remedial actions to improve export competitiveness would be neglected. Any further contraction in exports means that there would be unemployment and incomes of the poor would deteriorate.
Another danger is that the reserves would lead to excessive government expenditure and deterioration in the trade balance. This would be of little concern as it would not lead to a balance of payments crisis though reserves would decline. Most of the reserves are loans that have to be repaid rather than funds that have been earned through exports. These contingent liabilities have also increased the country’s public debt that is a serious burden on the economy. Therefore the high foreign exchange reserves could result in inappropriate economic policies and lack of financial discipline.
The advantage that the country had last year of much lower import prices may not continue this year. There are signs of import prices rising. This is particularly so with respect to petroleum prices that have risen during the second half of last year and continues to increase. Some of the vital food imports such as sugar are also rising in prices. Therefore the favourable outturn in import expenditure cannot be expected to continue.
For these reasons the favourable developments in the external reserves and the current account of the balance of payments could be a long term disadvantage, if it leads to complacency and inaction to improve export performance. The performance in the external finances must be looked at analytically and realistically in order to ensure the correct economic policies for the country. |
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