Sri Lanka: Trade gap swelling to unprecedented levels

By Nimal Sanderatne | The Sunday Times
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The trade deficit is rising to alarming proportions this year. In the first half of this year the trade deficit grew to US$ 4250 million. This is larger than the trade deficit of US$ 3122 million for the full year in 2009 and is as much as 82 per cent of the large trade deficit of US$ 5205 million in 2010. It is likely that at year’s end, the 2011 trade deficit would be around US$ 8 to 9 billion. Despite the gravity of the emerging trade scenario, there is little concern about it owing to several extenuating circumstances.

Notwithstanding the projected massive trade deficit of around US$ 8 to 9 billion this year, a balance of payments surplus is expected at year’s end. This is due to the higher tourist earnings, substantial worker remittances and capital inflows, including large foreign borrowing. However the surplus in the balance of payments achieved in this manner should not lead to complacency on the emerging huge trade deficit, as the country’s foreign debt is large and the large trade deficit is due to fundamental weakness in the economy that should be remedied. Furthermore, the magnitude of the trade deficit and emerging unfavourable global developments that may affect exports and inward remittances leaves the prospect of a balance of payments surplus this year in doubt. However large capital inflows could transform this year’s massive trade deficit into a balance of payments surplus.

Trade balance

Harping on the growth in exports this year and the strong position of foreign reserves blinds us to the much higher growth in imports that has led to a record trade deficit of US $ 4.25 billion. The tenor of the news releases of the Central Bank emphasizes the export growth and the foreign reserve position, while underplaying the emerging huge trade deficit. The external finances of the country have been considered to be healthy for some time. After the crisis the country faced in 2009, foreign reserves have been rising and were in the range of US$ 8 billion at end July. Such a reserve is adequate to cover 5 to 6 months of imports. The Central Bank has been euphoric about the external finances of the country, especially the export growth and the level of foreign reserves. The Central Bank is of the view that the country’s external finances are in a good position. One may ask whether there is any merit in talking about the reserve position, when much of it is based on foreign borrowings. In fact the Central Bank itself says the increase in reserves is due to the recent borrowing. It says “…gross official reserves…increased significantly to US dollars 8.1 billion by end July 2011, mainly due to the receipt of proceeds of the fourth International Sovereign Bond of US dollars 1 billion.”

In the first half of the year the trade deficit ballooned to a massive US $ 4.25 billion mainly due to a huge increase in import expenditure. The impressive growth in exports was unable to contain the deficit owing to the much larger growth in imports. Export earnings during the first six months increased by 35.2 per cent compared to that of first half of last year to US$ 5,057 million. This is indeed a very impressive growth in exports. In comparison import expenditure increased by 46.5 per cent during the first six months compared to that of the first half of last year to reach US$ 9,307 million. This massive surge in imports was due to increased expenditure on consumer, intermediate and investment goods. Consumer goods imports grew by 56 per cent, intermediate goods by 45 per cent and investment goods by 53 per cent.

The growth in exports in the first half of the year was the result of increases in both agricultural and industrial exports, with the latter being impressive. Agricultural exports increased by 17.7 per cent with tea exports contributing by a growth of 8.5 per cent. More striking was the industrial export performance that grew by an impressive 41 per cent. The country’s main export--textiles and garments--increased by 34.7 per cent, while rubber manufactures increased by 86.2 per cent. Notwithstanding the impressive growth in exports, the significant increase in imports resulted in the country having a large trade deficit of US$ 4.25 million for one half of the year.

External finances

The high level of external reserves has been a boast of the country. No doubt a foreign exchange reserve of US$ 8 billion is a satisfactory feature of the economy. Yet how these reserves were built up and the contingent liabilities they involve are significant. These reserves have not been earned by export earnings. In fact the country has had continuing and increasing trade deficits over many years. The large volume of remittances received by the country has been an important source of support to the balance of payments. These have reduced the liability of the trade deficit. Tourist earnings since the war ended have also contributed to balancing the external payments. Then there is the large amount of foreign borrowings. At the end of last year the foreign debt had reached over three times the foreign reserve of the country.

Concerns

There are several reasons why the trade performance of the country could be adversely affected in the next six months. The crises in Middle Eastern countries could affect exports and the balance of payments adversely in several ways. One of these is theimpact of the turmoil on the country’s export of tea. The disruption in the region could reduce tea exports to Libya, Syria and Iraq that are good markets for Ceylon tea. In fact already there are signs that this is happening. Furthermore, worker remittances that are an important source of funding the trade deficit could experience a dip. Over 50 per cent of worker remittances come from the Middle East and if migration to these countries decline, remittances could be adversely affected. The rate of increase in remittances appears to have been already affected. In the last two years, while the trade deficit was increasing, remittances too increased. In 2010, 80 per cent of the trade deficit was offset by remittances. In the first half of this year remittances increased by 26 per cent but the trade deficit increased so much more that the remittances would offset only about two-thirds of the trade deficit.

Therefore the increasing trade deficit will be financed by remittances to a lesser extent. The third factor of significance is that the global recovery has retarded and another wave of global recession is expected. Recessionary conditions in North America and Europe would decrease the demand for industrial exports.

With these facts in mind could it be said that the external finances of the country are in a good state? The external reserve position is no good measure of the state of external finances owing to a large amount of borrowing that has been a significant source for these reserves. Both agricultural and industrial exports have fared well this year.

The increases in industrial exports are especially noteworthy. Yet, export growth has been outpaced by the growth in import expenditure and there is an unprecedented massive trade deficit. In just six months the trade deficit has ballooned to US$ 4.25 million. If this trend continues then the trade deficit will be a massive US$ 8 to 9 billion. Such a large trade deficit should be a national concern as it threatens the balance of payments and the foreign reserves.

The fact that tourist earnings are increasing and there are significant inflows of remittances is not a reason to neglect the fundamental issues involved in such a trade imbalance. In a situation where exports are growing, the root cause of the trade deficit is the large expenditure on imports. Countervailing measures should be taken to restrain imports. The incontrovertible fact is that we are living beyond our means.

© The Sunday Times