The path to economic recovery

Sunil KARUNANAYAKE

Balance of payment difficulties are not uncommon to most developing nations as they are constantly plagued by issues such as internal conflicts, poverty support, welfare schemes, debt repayments, investor withdrawals etc and huge import bills due to limitation of domestic resources.

In the mid 1970's following the formation of the OPEC cartel and the steep increase in prices of petroleum products then government faced a severe foreign exchange crisis that was further compounded by declining export earnings in the aftermath of the land reform.

Limitation of foreign exchange obviously leads to shortage of imported essentials thus leading to shortages. In fact foreign exchange releases for overseas travel, education, health were drastically restricted. During this era car imports were totally banned.

Economic resurgence

However following the economic liberalization in 1977 some far reaching reforms in exchange rate unification, import liberalization, export incentives, further liberalization in shipping, banking etc resulted in an economic resurgence. Even during this regime then government had to face a massive hike in oil prices and one of the counter measures adopted was a total ban on cars on Sunday afternoons.

The global financial crisis of 2008 that brought the global economy to standstill adversely affected the economic fundamentals in the midst of a raging war in the North and East in Sri Lanka. However due to limited exposure and capital account restrictions limited further damage. Export economy suffered a major setback due to the economic crisis crippling most of our export markets thus drastically limiting foreign exchange earnings much needed to boost reserves.

The Sri Lankan economy, its setbacks and IMF assistance has been a much talked about topic in the country. However it was not all gloom as the prophets advocated but a positive forecast for a nation poised for economic recovery and massive development programmes taking place after nearly three decades.

Global financial crisis

IMF SBA facility initially was provided to Sri Lanka in 2009 amid the global financial crisis when the county's reserves hit a low level.

IMF representative, borrowing from the titles of Churchill's famous multivolume history of World War Two - described a ‘Gathering Storm,’ that is, the build up to the economic difficulties that peaked in early 2009.

He highlighted the rising oil price widening the trade deficit, remittances, a significant source of external financing declining, loss of global investor appetite, making inroads into a deteriorating economy, and continued large fiscal deficits which were financed increasingly from external sources causing further issues when the global crisis brought despair. CBSL’s approach in defending the rupee by selling dollars at the expense of reserves was seen as ‘Triumph and Tragedy,’ in that the rupee was kept from falling far too quickly, but at the cost of much needed dollars; that was not sustainable.

Foreign reserves

Well what we are witnessing at present is somewhat of a replay of the 2009 scenario. It must be noted that during 2009 period Sri Lanka was in the last stages of the war with intense fighting in the battlefields. Rigidity of the exchange rate and the cheap credit perhaps facilitated imports thus expanding the trade deficit.

After much deliberations IMF on April 9 approved $ 427 million loan to Sri Lanka hoping to swell the government coffers that have been adversely affected by a threatening trade deficit. IMF noting the economic recovery of 2011 commented on the easy access to credit. Rigidity of the exchange rate has been instrumental in a massive trade deficit that's said to be around US $ 10 billion equivalent to 20 percent of the country’s GDP.

They also added that country’s foreign reserves have been decimated leaving the economy exposed to external shocks. Sri Lankan government rose to the occasion and took immediate steps, such as the following;

* To provide exchange rate flexibility three percent evaluation was implemented in November 2011

* Given the unmanageable credit growth, leading credit expansion and related consumption policy rates were revised after considerable time

* Domestic prices of petroleum and electricity were increased to arrest the increasing debts of state owned energy producers

* These measures were followed by massive import duty increase in motor vehicles, trishaws (popular mode of public transport) etc to boost the government revenue, as well as, to curtail foreign exchange. It should also be noted that country's road network is already under heavy pressure due to increase in vehicular traffic in addition to high frequency of fatal accidents.

Economic researchers feel that the pain of relief measures will be felt for around 12 to 18 months and thereafter stability could be established. IMF too has expressed satisfaction on government initiatives in the recovery process.

Export sector

As an island economy Sri Lanka has limited options, hence, providing assistance to export sector is critical in building up foreign exchange reserves. Agricultural exports like tea and cinnamon needs to be given every assistance as their potential is not fully utilized.

Tea sector has been severely affected by inclement weather, exorbitant wage increases and land limitations. Problems are more acute in the high growns where labour lives in the plantations. Recently government set up a fund to support brand promotion for tea to encourage brand marketing as against supplying unbranded to the global market. Garment and apparel have been steady and remain as the largest export earners.

It is also heartening to note that the recent Export Development Board sponsored export promotion event in Colombo has been a huge success. This augurs well for the much planned USD 20 m export earnings target.

After having gone through an import surge of motor vehicles it seems sensible that the recent import duty hike will curtail the burden on the roads as well as the increasing fuel costs.