Economic Review:

BOP response to overcome crisis situation

by Sunil KARUNANAYAKE

Sri Lanka's economy held much promise with the post war recovery, but could not escape the vicious economic downturn that has seriously affected our export markets. It is noted that 50 percent of the export market are dominated by USA and Europe.

Though US markets show signs of improvement and coming out of the recession with 2 percent growth expected for 2012. However, Europe seems to be in deep crisis with most of the EU members embroiled in a deep debt crisis.

Recovering from the 2008 global financial crisis our exports did make some progress. Export growth was somewhat impressive but an alarming increase in imports during the fourth quarter began to threaten the trade balance that zoomed to $ 9 billion by November.

The Central Bank consciously attempted to maintain a stable exchange rate and an interest rate, in a country where nearly 40 percent of the population is living on income support it is somewhat justifiable that they are shielded from the vagaries of global price increases.

Being heavily import dependent for basic essentials such as fuel, LP gas, pharmaceuticals, capital goods etc the poorer sections of the population does deserve relief. However, it must also be noted that Sri Lanka needs to boost its foreign exchange reserves through export growth. Export markets are highly competitive hence our products must be price sensitive to be competitive.

Perhaps for these reasons there were many concerns about the exchange rate and it was under these circumstances that President Mahinda Rajapaksa announced a three percent devaluation in the 2012 Budget.

In the meantime, IMF came up with a "Stand by Agreement (SBA) facility" in the wake of sharply declining reserves in 2008, this did give a boost to the economy with reserves improving when the economy was wilting under pressure at that time.

The IMF persistently argued for a flexible exchange rate policy and for this reason the final tranche was somewhat withheld.

It is explained in theory that when the exchange rate is used to provide protection to domestic firms, it is through undervaluation, undervalued exchange rate is said to be protecting domestic firms from imports and gives domestic firms greater incentives to export.

In the same wavelength it could be assumed this is equivalent to extra protection from imports through tariffs. The determination of equilibrium is not straightforward since the very concept of equilibrium is ambiguous.

Three different concepts of equilibrium could be considered. First and foremost the current account balance, secondly overall balance of payments and the third political-economy based equilibrium.

The issue is the selection of the correct balance It has to be admitted that there was some delayed action in government not moving for a petroleum price revision perhaps on a phased basis and Central Bank maintaining a rigid exchange rate policy for too long. Perhaps if these two measures were rectified earlier in the day, present Balance of Payment issue would not have expanded with a huge unmanageable trade balance that reached approx $ 9 m by November.

With reserves at low levels the Central Bank promptly moved to flex the exchange rate and increase policy rates after many months to curtail the alarming credit expansion. With garments reaching an all time high, the export figure of $ 4.2b and tea exports following with $ 1.3b, one would expect an improved export performance with some recovery from export markets and benefiting from the floating exchange rate.

There is little doubt that the tea markets of Libya, Syria, Tunisia and even Iran that became inactive due to political turmoil are gradually becoming active as tea is more than a beverage in these countries and in particular their preference for "Ceylon Teas".

The Central Bank is also hopeful that with tourism expected to reach one million in 2012, the country will have a surge of inflow of foreign funds.

These signs are already visible in the coastal areas of South and East and growing leisure sector investments in Jaffna.