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The susceptibility of the economy to global economic vicissitudes

The performance of the Sri Lankan economy last year and the emerging scenario this year indicate once again the forceful impact global economic fluctuations have had on this nation’s economy. This is inevitable for a small trading nation such as the Sri Lankan economy. The Singaporean economy that has been hailed as a role model that thrived on the prosperity and growth of global economic conditions is now in crisis owing to the same reasons. This is an inevitability of the good and the bad that small nations dependent on trade must face. Even larger nations like China and India that have benefited enormously through trade are facing a setback, owing to the global recession. If small countries choose to close their economies to the rest of the world, then they must take a drastic decline in their standards of living, as is the case in some land locked countries in the world and countries like North Korea. Trade provides the Sri Lankan economy far too many benefits than disadvantages that the economy has to face. This is a truism that can be demonstrated, but one that is easy to realise from the economic experience of the country.

The prospects of economic growth that come with international trade have within it the inevitable vulnerability to the vicissitudes of global developments. Small trading economies are subject to the vicissitudes of the trade cycle, the booms and busts of the world economic order. This is not a new phenomenon or experience for Sri Lanka. It was a characteristic of the economy ever since trade became important in the British regime. The Sri Lankan economy has been for over a century an export -import economy. During the British rule, the country was dependent on exports of primary commodities, mainly tea, rubber and coconut, and to some extent, other minor crops like cinnamon and other spice crops to buy its requirements of food and other basic needs, as well as machinery and motor cars. The Second World War was a time of prosperity and so were the Korean boom years. These were periods of relative prosperity for the country, then the fall in rubber prices at the same time as an increase in prices of the commodities that the country imported at that time such as rice, wheat flour, sugar, and intermediate goods created difficult conditions.

The sixties and seventies for the most part was a period when the prices at which we imported were high in relation to the prices we got by the export of commodities. These adverse terms of trade led to a serious balance of payments difficulties for the country. It led to the country adopting inward looking economic policies, import controls, exchange controls, scarcities and low rates of economic growth. Last year’s Central Bank Annual Report is a continuous refrain of the same problem that our imports costs too much, while in the latter part of the year, our exports faced depressed global demand. In the space of the last two years, the Sri Lankan economy became vulnerable in two diverse waves of disadvantages in international trade. At first the sharp increases in the prices of oil, food and intermediate goods resulted in severe strain on the trade balance. In 2007, the country suffered a trade deficit of US$ 3,656.5 million, although the country also benefited from better prices for rubber and tea. However the increases in prices of tea and rubber could not offset the adverse effects of the import price increases of oil, food and other intermediate goods in particular. There were however benefits in terms of private remittances. Global conditions enabled the country to borrow a significant amount of commercial loans. Consequently, despite the large trade deficit, there was a balance of payments surplus and the foreign exchange reserves were high in 2007.

In 2008, the tide changed. Oil and commodity prices came down in the latter part of the year. This benefited imports but only in the latter part when other adverse conditions affected export prices. In the first part of the year, the high prices of imports affected the trade balance and in the latter part of the year export earnings declined. The combination of these factors led to a record high trade deficit of US$ 5.9 billion. This trade deficit was unsustainable as there were capital outflows consequent to the need to repay loans and debt service payments. As a result the country had a balance of payments deficit of US$ 1.2 billion and an erosion of the reserves to levels that were considered of crisis proportions.

It was in this international context that the country recorded an economic growth of 6.8 % in 2007 and 6 % in 2008. In fact a 6 % or higher growth for four successive years, 2005-2008, is no mean achievement. Furthermore it has been achieved during a period of external and internal shocks. This is particularly so with respect to the last two years when international developments turned unfavourable in diverse ways. Internally a very expensive war absorbed a huge slice of public expenditure unproductively.

While appreciating that global factors are an important determinant of the nation’s economic growth and prosperity, it is important to ensure that economic policies are geared to face international crises and to be in a position to compete in international markets. This implies that economic conditions in the country must be conducive to export industries being able to produce at competitive prices. The control of the rate of inflation in particular is especially important to ensure this competitiveness. If the country’s rate of inflation is higher than those of the countries that compete with our products, we loose our competitive edge. More specifically if wages rise and costs of inputs such as energy costs, transport and other raw materials rise, then the costs of production rise. Two factors are important to ensure price stability. One is the fiscal deficit and the other is the relative stability of the exchange rate and these two are inextricably connected. It is because of this that the management of the economy is vital with respect to both these factors. If not the economic problems become cumulative, gains momentum and beyond control.

The economy has reached a stage that requires strong measures to cut down the fiscal deficit and depreciate the currency. The latter, in turn, fuels inflation and requires further action. Nevertheless it has become inevitable. To temporarily resolve the problem by loans from foreign countries and facilities from the IMF can sometimes aggravate the problem, if corrective action is not taken immediately. We hope wise counsel prevails and that at this juncture, when the economy is in crisis, the government would take the remedial measures of fiscal consolidation and management of the exchange rate, whether they come as conditions from the IMF or not.


 

 


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