News Features

Fundamental weaknesses in the Balance of Payments

Fundamental weaknesses in our External Finances have been exposed once again in 2008. The Balance of Payments and the Balance of Trade account for 2008 underscores once more the basic weaknesses inherent in our Trade and Payments account. Although last year’s Trade account exaggerated these weaknesses, the underlying deficiencies were inherent structural flaws. The fundamental weaknesses and vulnerability in the Trade pattern, though aggravated by the surge in Import Prices last year, were of the same mould as other years. It may surprise readers that the country has not had a Trade Surplus of even a small amount in the last 30 years from 1978 to 2008. Further, there is no prospect of a Trade Surplus in the foreseeable future.

The deficit in the Trade Balance reached an unprecedented massive US$ 5,871 million in 2008, compared with the deficit of US$ 3,656 million in 2007. This 60% increase in the Trade Deficit was brought about mainly due to a sharp increase in the Import Bill. Last year’s Trade Deficit was aggravated by the unprecedented increases in price of oil and a number of essential items, especially, food commodities such as wheat, sugar, dhal and milk. Oil imports alone cost US$ 3,368 million or 24% of the total Import Bill of US$ 14,008 million. Last year’s Trade performance was a magnification of the Trade pattern we have experienced year-in year-out.

The fundamental feature in our Trade that causes a Trade Deficit is the larger Import base than the Export base. For instance, in 2007, our Imports were US$ 11,295 million, while our Exports were US$ 7,640 million. This was further aggravated in 2008, when Imports increased by 24% to US$ 3,368 million, whereas Exports increased by only 6.5% to US$ 8,137 million. The often repeated boast of Export growth never really offsets the growth in Imports. Therefore, even when there is good Export growth, it is inadequate to offset the increase in Imports. Even if the rate of growth of Exports is higher than the rate of growth of Imports, the higher import values result in a Trade Deficit.

The vulnerability in our external account is also due to the differing character of Imports and Exports. In the case of Imports, the substantial Imports are essential items such as petroleum, fertiliser, intermediate goods that are inputs for our manufactures, and essential food imports such as wheat, sugar, milk, dhal and other foodstuff. The Capital Imports are also essential for enhancing production capacity. It may also be the case that the increase in Capital Imports is due to increased Imports of military hardware. The curtailment of these Imports, even when prices rise sharply, are limited, owing to this feature of their being essential items for either consumption or as inputs for manufactures or for defence needs. Imports, in the terminology of economics, are inelastic. The amounts imported do not decline to the same extent as prices rise and therefore, the outlay is higher.

The other significant characteristic is that, as much as about one fourth of our Import Expenditure is on oil imports that provide the essential energy requirements. Once again, this is an import that has little possibility of significant curtailment. To use the jargon of economists, oil imports are not elastic. This means simply that, when prices of these commodities rise, the amount demanded does not decrease proportionately. Therefore, the country’s Trade Balance is highly vulnerable to rises in Import prices of her main Imports. It is due to this, that sharp increases in international prices are called External Shocks. Last year, these Shocks came in the form of higher Import prices of most essential Imports.

The extent to which Domestic Production could substitute for Imports is limited. Although there is much interest in Domestic Production of agricultural products such as paddy, sugar, milk and other produce, to substitute for Imports, this could only have a marginal impact, as food Imports constitute less than 10% of total Imports. The Imports that matter are the Intermediate and Capital Imports. Pricing policies that conserve the use of petroleum and alternate energy resources are needed to ensure some degree of lesser expenditure on oil imports. This would be particularly relevant for the future, when oil prices may rise again. The conclusion of fighting may also provide opportunities for the reduction of oil imports and military hardware imports.

The prospects of Export growth are rather dim in view of global recessionary conditions. Yet, efforts have to be made to ensure that our competitive position is not unduly eroded. Good management of the economy, especially, the control of Inflation and a realistic Exchange Rate are vital. Unfortunately, the higher costs of production in Sri Lanka, relative to the costs of production of other countries, are reducing our competitiveness in manufactured Exports such as textiles and ceramics. While the costs of manufacture are rising, the stable Exchange Rate is making our Exports more expensive.

The persistent Trade Deficits have not generally resulted in a Balance of Payments Deficit owing to Capital Inflows. In recent years, this has been so due to Private Remittances from abroad being substantial. Additionally, there have been large scale Foreign Borrowings. Private Remittances, of which, a high proportion is worker remittances, have offset a high proportion of the Trade Deficit. For instance, Private Remittances increased by 16.6% to US$ 2,918 million in 2008. This enabled the financing of about one half of the Trade Deficit. Although, in recent years, there have been large scale Foreign Commercial Borrowing, in 2008, there was an outflow too, as some of the Foreign Loans required to be repaid. This is why the Foreign Reserves of the country fell to one of the lowest levels of US$ 1,753 million.

The Central Bank considers this amount of Reserves as adequate to finance about 1.5 months of Imports. Due to declining prices of oil and other commodities, the Trade Deficit is expected to be less this year, even though Export growth too, is expected to decline. Besides this, the Central Bank is seeking new ways of replenishing the dwindled Reserves through bilateral assistance or investments from friendly cash rich countries in the region. Whether we would face a severe Balance of Payments crisis in the coming months, would depend on whether these expectations would materialise and Worker Remittances would not diminish.