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| Sunday, 22 August 2004 |
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Volatile petroleum prices destabilise Economy Prof. Jagath Wickramasinghe, Professor of Economics, University of Sri Jayawardenapure Petroleum prices in the world market have been rising to unprecedented levels over the last couple of weeks. Oil prices surged to fresh historic peek this week above $46 per barrel in New York, fuelled by concerns over disruptions to supply in the wake of reduced exports from Iraq, fear of strike action in one of the major oil producers Venezuela and financial problems in Russian main oil producer, Yukos. New York benchmark contract prices for oil delivery in September shot up to $46.30, this was 80 US cents higher than the price of Thursday. This price upsurge has generated a huge current account deficit in the US balance of payments running up to 5.6 % of GDP this year and predicts around 5% of GDP next year. In order to contain the inflationary impact of this unexpected "oil shock" US Reserve Bank increased bank rate by 0.25% from 1.25% to 1.5 %. American dollar has depreciated against the Euro, benefit of which was felt in Sri Lanka by appreciating our rupee from Rs. 104 plus to RS. 102 plus, to a dollar. In London market another record upsurge of oil prices was recorded last week, prices rising above $ 43 per barrel. As the prices of oil reaching unprecedented levels oil kingpin Saudi Arabia was ready to increase her production immediately by 1.3 million barrels a day, if called upon to help. However, the problem is if prices continue to move upwards even after Saudi Arabia increases the supply what is the alternative available. There is no other capacity available. The oil economic experts argue that the current oil prices are still below the inflation-adjusted peak of $ 60 that was hit in 1974 and the huge $100 price in 1980. Hence, they predict even higher price in the future at least reaching $ 50 a barrel. The world demand for oil is growing at about 3% per annum. The biggest consumer is United States with 25 barrels of oil per capita and China come second; the latter has doubled her consumption over a decade. Number of Chinese motorbikes is up six times and cars ten times over the same period. In spite of the unprecedented protest shown by the world opinion on the aggression of Iraq, president George W Bush and prime minister Tony Blair invaded Iraq on the guise of the "fight against terrorism" which was responsible for creating this turmoil economic situation. The heavy fighting in Iraq, which forced the major producer, Iraq to half her production, fuelled the prices of oil. Situation was further aggravated by the terrorist attack on oil pipelines and installations in Southern Iraq and the insurgency activities. It generated a sense of uncertainty in the world oil market, which made countries such as China to engage on speculative purchasing of oil, which has further exacerbated the situation. Another key factor, which was responsible for sudden upsurge of oil prices is the possible strike action in Venezuela after the results of the referendum. Venezuela supplies about 15% of the American oil market. An effective alternative for petroleum energy at a comparative price is not available in the near future. How does this unprecedented oil price jack up affect Sri Lanka's economy? In 2003 Sri Lanka imported crude oil worth of $ 838 at the rate of average price of $ 29.46 per barrel. If the present world market price persists at $ 43 per over the rest of the year our oil bill goes up by about 45% ie, by extra nearly $500 million. Biggest problem is to earn these extra dollars? Unless this money is earned this will generate extra pressure on Sri Lanka's Rupee and Us dollar will appreciate in value vis a vis our rupee, creating a chain of adverse consequences. Although some marginal benefits could be expected for exports such a depreciation of rupee is disastrous for Sri Lankan economy as more than half of our essentials are imported. The prices of these items will rise generating inflation. Already prices of petrol and diesel are revised upwards. Bus fare is to follow. A salutary policy decision is that price of kerosene, poor man's main source of energy is untouched. Another adverse result expected from this oil crisis is the slackening of the world demand for industrial goods. A similar situation was developed immediately after the oil crisis in 1973. This is particularly important to Sri Lanka as more than half of our exports consist of industrial goods. The debt trap in early 1980s was the result of such a slackening of demand for industrial goods from the Latin American countries. Should the same situation were to prevail it would be like proverbial "falling from prying pan to the fire" for the developing countries. What is the way out? Should we integrate our economy further with the international economy as envisaged by "Regaining Sri Lanka" or go for the development of our indigenous economy as shown by "Country First"? I believe only salvation is to develop our domestic economy by providing incentives to the local producer and encourage exports in sectors in which we enjoy comparative advantage. There are number of sectors in which substitutes for imports could be developed with little efforts, for instance milk, potatoes, dhal, sugar etc. Initially when investment increases on domestic development both the budget deficit and the price level will increase and that is the price we have to pay for our own development. After few years when these projects starts bearing fruits the increased supply of goods and services from the domestic projects will reduce the pressure on the price level and as a result inflationary tendency will be reduced. Further intensification of the integration of our economy into the world market by unlimited liberalisation of the economy would only aggravate and perpetuate this problem. What is required is to strengthen the domestic economy while promoting exports in products we have comparative advantage. I believe the present government is moving towards this right direction. Over the years we have not given the due prominence to food security, development of the domestic economy ensures this vital aspect of economic development. |
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