Lanka should be ready to face crises due to external factors - Economic analysts

By Gamini Warushamana

[email protected]
 

Sri Lanka’s economy will face many crises due to several external factors, economic analysts warned. The Asian Development Bank (ADB) has already warned that the economic growth rate this year would be at 6% despite the Central Bank prediction of 7%

Recession in the US economy is the main external factor that is fuelling many other global crises. There are several views about US recession. Some say that the US recession is short term and some say it is long term.

In his new book The Credit Crisis of 2008 George Soros’ explains the US economic crisis and its impact thus.

“The United States is facing both a recession and a flight from the dollar. The decline in housing prices, the weight of accumulated household debt and the losses and uncertainties in the banking system threaten to push the economy into a self-reinforcing decline.

Measures to combat this threat increase the supply of dollars. At the same time, the flight from the dollar has set up inflationary pressures through higher energy, commodity and food prices.

The European Central Bank, whose mission is to maintain price stability, is reluctant to lower interest rates. This has created a discord between US and EU monetary policy and put upward pressure on the euro.

The euro has appreciated more than the renminbi, creating trade tension between Europe and China. The renminbi can catch up with the euro both to avoid protectionism in the United States and increasingly in Europe, and to contain imported price inflation in China.

This will, in turn, increase prices at Wal-Mart and put additional pressure on the already beleaguered US consumer. Unfortunately this administration shows no understanding of the predicament in which it finds itself.

Eventually, the US government will have to use taxpayers’ money to arrest the decline in house prices.

Until it does, the decline will be self-reinforcing, with people walking away from homes in which they have negative equity and more and more financial institutions becoming insolvent, thus reinforcing both the recession and flight from the dollar.

The Bush administration and most economic forecasters do not understand that markets can be self-reinforcing on the downside as well as the upside. They are waiting for the housing market to find a bottom on its own, but it is further away than they think.

The Bush administration resists using taxpayers’ money because of its market fundamentalist ideology and its reluctance to yield power to Congress. It has left the conduct of policy largely to the Federal Reserve. This has put too much of a burden on an institution designed to deal with liquidity, not solvency, problems.

With the Bear Stearns rescue operation and the latest-term security lending facility, the Fed has put its own balance sheet at risk. I expect better of the next administration. Until then, I foresee many policy turns and changes in market direction since current policies are inadequate. It will be difficult to stay ahead of the curve.”

According to Soros the crisis in the US economy is not short term. If an economy performance drops in the real GDP growth for two consecutive quarters it is called a recession. Several factors caused the recession in the US economy.

One is the credit crunch started in the sub prime lending market. As a result financial companies face a threat of bankruptcy. Simultaneously the US has faced a budget deficit and current account deficit.

Lower foreign exchange earnings caused to depreciate the US dollar and this has fuelled many global crises.

As the dollar is shrinking countries such as China, Middle East oil exporting countries and India that have large foreign reserves have commenced to shift their investments from dollar securities to Euro securities leading the Euro to appreciate. This has worsened the US crisis and spread to a global crisis.

Depreciation

The depreciation of the dollar is the main factor for the increasing crude oil and food prices at present. As the US dollar depreciates and price of crude oil and food are on the increase the investors tend to invest more on oil and food futures.

This has put pressure on crude oil and food prices. There are supply and demand factors caused for the price increase but the effects of the global economic turmoil is one major reason for continuous price increase of commodities.

Sri Lanka has to face the consequences of these external economic crises during this year. Since our economy is import dependent, the oil and food price increase may spiral inflation.

Inflation in the country is already at the highest level and in March inflation recorded 28.17%. During the past year there was a huge price increase in essential commodities and a food crisis is looming in the country similar to many countries - for example during the past year wheat import prices increased by 60% and bread by 200%.

Apart from the adverse weather which hit the Maha season paddy harvest, uncompetitive markets for essential commodities such as rice and resulting supply chaos, counter measures taken by the government such as price control may worsen the situation.

At a global level too protectionist measures such as banning imports are taking place. All these factors would further increase prices of essential commodities.

On the other hand the US recession and slow down in economies in Europe would adversely affect our exports as demand grows. Our exports are becoming uncompetitive due to the appreciation of the rupee against the US dollar.

This situation would mainly affect the apparel industry. In addition the EU is linking human right issues with trade conditions in the negotiation of GSP+.

Therefore, some important concessions enjoyed by our exporters are under threat as the human rights record of the country is internationally controversial. The restriction on apparel exports of China to the US and EU markets will conclude by the end of this year and as a result the apparel industry will face intense competition in the main markets.

The IMF recently warned that this price increase would cause a political crisis in many countries. Therefore, solutions have to be found immediately. In Sri Lanka the food crisis will be more, severe than the early 1970s crisis. Some experts warn about a famine.

Solutions

Experts have proposed short and long term solutions for the crisis. First a buffer stock of rice should be available. However, this is not possible because all countries have started stock piling food restricting exports.

Secondly, starting welfare measures to help the most vulnerable people in minimising the burden on the budget.

Increasing domestic food production is another important measure including cultivation of substitutes for main staple foods. Earlier this program failed but today since there is no option there is a possibility of this kind of programs being successful.