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| Sunday, 12 September 2004 |
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Business |  |
| News Business Features Editorial
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Trade deficit and economic development
In the first half of this year our trade account of the balance of payments recorded a deficit of $ 1126 millions. This, when compared with the same period of the last year, was an increase of $ 426, from $ 700 to $ 1126, and also a 61% increase. Of course, this is something to be concerned of. However a country cannot and is not advantageous for it, to have a surplus in the trade account all the time. Such large surplus would over-value the rupee eroding the comparative advantage of our exports. It was the Mercantile Economists in the eighteenth century who believed that the wealth of a country would depend on the trade surpluses and advocated to generate surplus in the trade account by controlling imports and expanding exports. However, all the countries cannot have surpluses in the trade account for the simple reason that one country's surplus is generated from deficit of one or more other countries. This belief was discarded with the advent of capitalism. As with the magnitude of the trade balance one should give concern to the sources of such a deficit. Now economists believe increase in activities connected with trade are more conducive for economic development than generating a surplus per say. However, to some extent trade deficit reflects the weak economic structure of the economy as well. On the other hand, a trade deficit is unavoidable in a rapidly developing country. That is why the source of the deficit is of vital importance. When there is a deficit in the trade balance that has to be filled from the surpluses in the other accounts of the current account such as services, remittances or from the capital account surpluses, if it were not to generate any extra pressure to our rupee. A deficit in the trade account alone is not a serious problem to be concerned of, if other items in the current account are in a position to cover the deficit. Unfortunately, in the year 2003 the surplus generated by the remittances account was not sufficient to wipe out the entire trade deficit. Over the years current account of our balance of payments has been in deficit to value of around 2% of the GDP. In fact trade deficit in 1999 was 8.7% and current account deficit 3.6%. However, in 2003 these values were 8.4% and 0.6% respectively. Last year a good part of trade deficit was wiped out by the surpluses of the other accounts. That is why current account deficit was microscopically small, despite a high trade deficit. As the demand for dollars to meet the import expenditure exceeds the supply of dollars from this account and the other accounts (current account), this deficit definitely would bring pressure on external value of our rupee. Hence, steps have to be adopted to correct this adverse development. Theoretically depreciation of the rupee should reduce import and increase exports, but over the years in Sri Lanka this has not happened. Exports have improved marginally while imports have improved dramatically after depreciation. The reason being the fiscal policies were not in harmony with the exchange rate polices. The depreciation has been associated with increase in imports as a result of high marginal propensity to import in our country. Consumption pattern of our society is skewed towards imports, which has even undermined the impact of depreciation of the rupee. This suggests that the correction of the lopsided development in the trade account has to be attempted both in exchange rate front as well as in the fiscal and income determination fronts. Let us examine the composition of this deficit in the trade account. Exports in the first half of this year recorded a growth of 9.6% over the respective period. Within this overall growth, industrial exports have grown by 18%, of which textile and garments dominated by contributing 82% of its growth. Agricultural exports grew by 14%. During the first half of this year USA continued to be the main buyer of our exports with 31.2%, second being the United Kingdom, and Germany has taken the third place. In the first half of this year expenditure on imports rose to $ 3732 m from $ 3078m in the first half of 2003, an increase of $661m, recording an increase of 21% over the last year. Consumer goods imports have increased by 8%, intermediate goods by 19% and capital goods imports by 50%. This high rate of importation of capital goods is a salutary development. In the first half of 2003 such imports growth was modest, only 2%. This high growth in investment goods imports is an indication that the economy is gradually picking up. However, the grey side of this development is the high importation of passenger vehicles. There is a general perception that the business community has developed a mythical uncertainty about future prospects that either a total prohibition of or prohibitive taxation would be imposed on passenger vehicles. Hence, exceptionally large quantities of vehicles have been imported. If that is the case, in future months imports of that item will be minimal. Higher growth in imports of building material was also recorded during this period, which would contribute for development. Despite a few marginal improvements, the overall position of our external sector is not a thing to be happy about. A number of imported items that can be easily produced locally without use of much foreign resources are imported. To remedy this situation domestic economy has to be strengthened with a view to reduce imports and increase exports. In the last year we have spent $ 791m for the importation of wheat, sugar, milk & milk food; and with paper products imports it rises to $1608m. The theory of comparative advantage has become an unrealistic highly abstract wishful thinking in the context of heavy subsidisation made by the developed country governments. This dismal situation is further exacerbated by the direct and indirect restrictions placed by the developed countries on the exports of developing countries. The total subsidy paid to farmers by the developed countries, including the triad USA, EU and Japan was $ 350 billion a year. This amounts to 30% of the cost of production. A farmer is paid a $2 subsidy per cow per day by the European governments. Even India despite being a developing country provides substantial production subsidies to farmers, for instance subsidised electricity supply for farmers and small industrialists. Hence, the comparison of the prices of imported goods with the domestic cost of production is a futile exercise. It will mislead the policy makers. The conventional wisdom has become unrealistic in this subsidy scenario. What is necessary at this juncture is the strengthening of the domestic production of those items, which could substitute imported items. The prescription of the international financial institutions and neo-liberalists of the comparison of cost of production with prices of imported goods should be set aside for the sake of long term economic development and reduction of trade balance. |
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