The Sri Lankan economy is never spared from developments in the international economy. The world has been rocked by natural disasters that are having economic repercussions that are in turn impacting on the Sri Lankan economy. The appalling weather worldide last year resulted in higher commodity prices. The consequent international food crisis was compounded by two waves of floods in the country that destroyed the Maha paddy crop and other crops in the North Central and Eastern Provinces. The uptrend in oil prices of last year accelerated this year in the wake of the political crises in the Middle East. The air attacks on Libya and continuing unrest in Syria and Yemen has created a situation of grave uncertainty in the region.
What would the impact of the political unrest in the Middle East be on remittances and the demand for tea that are important for the country’s balance of payments? Will the earthquake and tsunami in Japan have adverse impacts through higher prices of Japanese imports? Will the setback to the Japanese economy affect the amount of aid from Japan, one of the most important aid donors?
These are questions uppermost in the minds of many. The plain truth is that there are several adverse forces that will affect the country’s economy, yet their moment and direction is not at all clear at present. This is especially so as these developments have impacts both on the supply and demand forces in the international economy. Speculation too adds a further dimension of uncertainty to the final outcomes. Yet the extent of their impact is difficult to measure at present.
Balance of payments
These developments would affect Sri Lanka’s balance of payments adversely. It could affect worker remittances into the country, tea prices, import costs and export demand. All these would have an unfavourable effect on the balance of payments. Consequently this year’s trade balance may be even more unfavourable than last year’s when we incurred a massive trade deficit of US$5.2 billion. Reduced remittances mean the strain of the trade deficit would be much more on the balance of payments, as remittances have been of considerable relief to the balance of payments in recent years, particularly last year, when remittances of US$ 4,1 billion covered about 80 per cent of the trade deficit.
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The problems in Arab countries are likely to reduce remittances. About 60 per cent of worker remittances are from Middle Eastern countries. Already workers from Middle Eastern countries have returned and the prospect of workers going to these countries would be weakened till there is a return to stability. The Sri Lankan workforce in the Middle East is likely to decline both due to the returnees from these countries and the usual exodus to them declining. On the other hand, there may be a spurt of increase in remittances due to some returnees bringing their unremitted savings.
The return of Sri Lankans from Japan implies lower remittances from there too, though these are not as significant as remittances from the Middle East.There has been an increasing trend in remittances in the last three years. In 2009 the flow of remittances increased by nearly 14 per cent. In 2010 remittances increased further by 24 per cent over that of the previous year to US$ 4 billion. More than half of these were from the Middle East. The current developments in the Middle East may reduce remittances from these counties for some time and strain the balance of payments.
Oil prices
Petroleum prices had risen from US$ 80 to US$ 90 when the uncertainties in the Middle East escalated it further to over US$ 100 per barrel. The UN forces’ attack on Libya has added a further uncertainty to oil prices that have risen sharply. Some projections of prices expect it to reach US$ 150 per barrel for some time and then decline. While the political unrest and the UN intervention has affected international oil supply and fuelled speculation, the catastrophe of the Japanese earthquake may reduce the demand for oil. This expectation based on lower industrial production in Japan may not be realized as the demand for thermal power generation will increase as the destruction of nuclear plants is expected to increase the demand for oil by Japan.
Current indications are that oil prices would remain high at US$ 100 per barrel and over levels. If oil prices reach between US$ 120-140 per barrel import expenditure would be huge. In the recent past oil imports were nearly 60 per cent of total imports. The likely volatility of oil prices adds a further complication in the management of oil purchases. The fact is that current oil prices are high and the country’s oil import bill is staggering.
Fiscal and inflationary impacts
The government is in a quandary about the pricing of oil products in the domestic market. At current import prices of oil, the government’s subsidy on petrol, diesel and kerosene are rising. This means that government expenditure is increasing. It will have an impact on the containment of the fiscal deficit. Besides this it is important to increase domestic prices of oil as a means of reducing the demand for fuel. If there is no upward price revision, the fiscal deficit would increase and the import bill for oil would rise sharply and increase the trade deficit.
The government is in a dilemma as an increase in fuel prices would have an adverse impact on prices and would fuel inflation. The increase in price of fuel not only increases the prices of petrol, diesel and kerosene directly, but has multiplier impacts on prices. The increase in transport costs leads to increases in the price of domestically produced food and other commodities. Already the price of food has reached unprecedented levels and further increases would mean severe hardships to the majority of the people, especially the lower income earners. It is this consideration that has made the government retain oil prices and suffer an increase in subsidization.
Exports
It is likely that the demand for rubber would continue to rise. The tea market would however be affected by the turmoil in the Middle East and disruption of trade in the region. A possible decline in tea production this year means tea export earnings would decrease. Global demand for the country’s industrial exports could also be affected if the current global conditions postpone further recovery in western countries. This is unfortunate as exports of garments in particular were recovering from the setback due to the withdrawal of GSP plus status.
Food imports and foreign aid
The decline in food import prices by around 10 per cent would benefit the trade balance and also ease inflationary pressures caused by increases in import prices. However these benefits in food price import expenditure are likely to be more than offset by the increase in prices of intermediate imports. The overall sharp increases in imports of both consumer and intermediate goods may continue, especially as fuel and fertilizer prices are on the rise.
There is some concern that Japan would reduce its Overseas Development Assistance. The impact of the disaster may affect the performance of the economy in the next few years. If this happens, future aid commitments may be reduced. At present Japanese Aid to Sri Lanka amounts to about 17 per cent of the total aid receipts.
Conclusion
The fallouts of the global disasters are unfavourable to the Sri Lankan economy. The Japanese earthquake and tsunami, the global food shortages, the political unrest and the attacks on Libya will affect the country’s external performance adversely and release fresh inflationary pressures. However the extent of the unfavourable effects remains uncertain at present. The external shocks that are currently unfolding would have to be monitored in order to take timely countervailing policy measures.
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