It is surprising that in a situation when the country is incurring a large trade deficit that the government has decided to reduce the import duties on motor vehicles on the grounds that such vehicles are needed for increasing tourist arrivals. Duties have also been reduced on a number of electronic items, wristwatches and other similar consumer items. The rationale for reducing duties on these is to make Colombo an attractive shopping centre for tourists. The reduction in raw material imports may reduce the costs of production of some industrial exports and improve the country’s export competitiveness. The Chamber of Commerce and the business community in general have welcomed the reduction in duties and the simplification of the tariff structure.
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An important consideration in the reduction of duties on motor cars may have been to increase revenues as the high duties had reduced revenues from car imports. While this move would increase government revenue, it would strain the trade balance further. Whether the reduction in the duties of electronic items, wristwatches and the like would result in significant tourist purchases is to be seen. With the low duty on these items the benefits in foreign exchange earnings and as revenue would be significant only if such purchases are large. In any event, the initial impact would be to increase the trade deficit. There may be some long term benefits to the economy. Meanwhile the foreign reserves may have to be used for the extra import expenditure.
There has been a further increase in the trade deficit in the first quarter of this year. Two weeks ago this column drew attention to the increasing trade gap and warned of a massive balance of trade deficit by the end of the year. The trade statistics for the first quarter confirms that the country is heading for a massive trade deficit this year. During the first three months of the year the trade deficit increased to as much as US$ 1461 million: a 119 per cent increase over that for the same period last year. The continuation of this trend in exports and imports could lead to a massive deficit of around US $ 6000 million for 2010. This would no doubt strain the balance of payments unless capital inflows are large enough to offset the large trade deficit.
What is most surprising is that the increase in the trade deficit is interpreted as a favourable development rather than a developing problem by the Central Bank. This adverse development in external trade is interpreted as a favourable development by the Central Bank that has a responsibility to warn the government of the serious consequences of such a development in the trade account. The Central Bank has described the external trade performance of the country in this extraordinary way. “Sri Lanka’s external sector improved further in March 2010 continuing the positive developments observed since December 2009. Earnings from exports grew by 4.8 per cent in March 2010 to US dollars 663 million led by industrial exports. The expenditure on imports also increased by 6.5 per cent to US dollars 1,091 million, due to the increased imports of consumer goods and intermediate goods. Accordingly, the trade deficit in March expanded by 9.3 per cent to US dollars 428 million. Both exports and imports have been well above that of 2009 and remained almost on par with the levels in 2008.”
The fact is that the developments in March were not favourable. More significant is that the cumulative figures for the first quarter are disconcerting and a matter of concern. A trade deficit of US$ 1461 for just three months of the year implies the possibility of a huge trade deficit for the year, especially as the signs are that the trend in import prices and export performance is likely to continue. For some time the country’s persistent trade deficit has not been taken seriously, as in many years capital inflows have offset the deficit and resulted in a balance of payments surplus, however small. However these deficits are a reflection of fundamental weaknesses in the economy, especially when export earnings are falling.
This deteriorating trade situation has been brought about by a huge increase in import expenditure. In the first quarter of this year import expenditure increased by US$ 3225 million which is a 39.5 per cent increase over that of last year. Intermediate goods imports increased to US$1685 million, an increase of over 50 per cent over the comparable period last year due mainly to the price increase in oil imports. A large proportion of the increase is due to the increase in oil prices, a trend that began mid way last year. The petroleum import bill consequently increased to US$ 725 million more than doubling (107 per cent increase) of the cost of last year’s first quarter’s imports. It is most likely that the oil imports would cost twice that of last year and thereby cause a huge dent in the trade balance as petroleum imports constitute a high proportion of the country’s imports. With the oil price increase several other imports are also likely to increase in prices. An important item among these is the cost of fertilizer.
Investment goods imports hardly increased. The mere 2.6 per cent increase in capital goods does not augur well for the country’s industrial future. It is an indication of the sluggishness of industrial development. This is further confirmed by the fact that textile imports increased by only 10 per cent. This conforms to the fact that garment exports during this period declined by 14.9 per cent and all industrial exports increased by an insignificant 0.3 per cent during the first quarter. In comparison with the huge increase in imports, exports have been rather sluggish. This is especially so with respect to industrial exports that increased by a mere 0.3 per cent. These are danger signs for the economy. There has been an increasing number unemployed in industries and urban unemployment is increasing. It is better to be forewarned than regret at the outcome.
In contrast to industrial exports, agricultural export earnings have risen due to international price increase and some of the lesser agricultural export earnings increasing in value. Even though international prices of tea and rubber continued to be high, earnings from agricultural exports grew marginally in March 2010 as volumes of tea exports declined by 17.2 per cent due to a supply shortage. Despite the decline in the volumes of rubber exports by 29.8 per cent, export earnings from rubber increased by 45.8 per cent in March 2010 due to very attractive prices. Earnings from minor agricultural exports grew by 25.8 per cent to US dollars 23 million led by substantial increases in export of vegetables, cloves, cashew nuts and sesame seeds.
No doubt remittances to the country are increasing. So are tourist earnings that are rising at about 25 per cent. Yet the extent of the increasing trade deficit may not be covered by these. Unlike last year when the entire trade deficit was wiped out by the remittances, this is unlikely this year. For instance the trade deficit was US$ 1461 million in the first quarter. Despite worker remittances increasing at a rate of 14 per cent this year too they contributed only US$ 890 million in the first quarter, leaving a balance of payments deficit of US$ 571 million in the current account.
The trade performance in the first quarter is not a healthy development. In as far as the import side of the equation is concerned it has been brought about mainly by price increases. However the sharp increases in consumer imports by 45.3 per cent owing to food and drink imports increasing by 54 per cent should not go unnoticed. The most serious feature has been the stagnation of the country’s industrial exports and the decline in the country’s main industrial export, garments. It is import for policy measures to find solutions to these weaknesses in the trading outcome of the country. |
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