Macro economy and balance of payment issues

by Sunil KARUNANAYAKE

Sri Lanka is enjoying the peace dividend with an upsurge in economic activity with development in the North and the East. Up to 2011 macroeconomic fundamentals seemed strong with low interest rates and stable exchange rates.

This environment provided a conducive background to the development of economic activities. However, this environment also facilitated an upsurge in trade with import volumes increasing pressure on all kinds of fuel to meet the rising demand created by economic growth. By the end of the year the pressure was felt on the balance of payments with adverse trade balance increasing.

The Government at this stage felt the pressure and introduced a policy package to reduce the yawning trade balance. Some of the measures were the free float of the exchange rate and discouraging imports that were considered non-essential.

The outcome was the increase in import duties on selected items and the impact of the exchange rate on imports. These no doubt had an effect on the prices of essential commodities with more pressure on poorer sections of society.

However, exporters who have been complaining of low exchange rates were able to benefit from the flexible exchange rate. In the meantime, the IMF expressed its satisfaction on the policy package and released the final tranche of the loan.

In the latest release, the Central Bank indicated that by June 2012 the trade deficit was reduced to $ 663 m from a$ 942 m by end 2011. Perhaps this development was a sign of relief for the authorities.

Expenditure on imports decreased by 15 percent. By June 2012 several categories of high cost imports such as motor vehicles and gold decreased in value. Pawning by banks and non-banking financial institutions gave them lucrative returns.

Another facilitating factor was the crude oil imports which had the benefit of lower international prices. Expenditure on motor vehicles too had declined.

Though a fair amount of road development and construction work has taken place in the provinces, in cities such as Kandy and Colombo, heavy traffic congestion is causing many problems. It is clear that roads are unable to cater to the increasing motor cars that account for heavy fuel consumption. The duty free import permit scheme for public servants too resulted in the influx of a large number of motor vehicles.

However, with the current duty structure on imports the sale of vehicles has significantly declined.

Exports are not yielding the anticipated earnings mainly due to many developed countries still facing financial problems. The leading agricultural export, tea has also become a victim of the prevalent drought. However, large-scale exports of apparel have continued to major markets with increase in volumes. This augurs well for the boosting of valuable forex reserves.

Earnings from tourism reflected encouraging growth, recording a 24 percent increase for the first half of the year with an impressive 452,867 tourist arrivals. This trend is expected to continue. However, it is noted that all tourists do not spend much money in Sri Lanka. With more capacity being added and effective marketing, arrivals are likely to increase significantly.

Worker remittances too had shown a significant increase in June 2012 to reach $ 2,942 m. During the same period significant inflows have been reported to the capital and financial account of the balance payments.

Foreign Direct Investments (FDIs) for the half year is estimated at $ 452 m. Apart from macroeconomic fundamentals the Government also needs to address other areas to curtail wasteful spending.

The modernisation of the Sapugaskanda oil refinery to handle different varieties of crude oil will lower the import cost significantly as petroleum is among the most expensive import items.

A decade ago, a larger part of furnace oil, the entirety of kerosene and nearly 40 percent of diesel and 67 percent of petrol were supplied by the refinery. This is a high priority item. The Ceylon Electricity Board needs to curtail thermal power and explore other options.

Vehicle congestion in the capital and leading cities need to be checked and rectified to curtail fuel waste.

Another common feature is the destroying of excess amount of vegetables that remain unsold. It is reported big onions are in excess and they are being destroyed by farmers. It's opportune to draw attention to these areas to curtail imports and keep inflation under control.

Recent concessionary measures provided by the Government have paved the way for higher output by farmers.

According to the Central Bank gross official reserves have reached $ 6,045m.

The Central Bank is confident that the proceeds of the International sovereign bond issue of $ 1b and other anticipated inflows reserves will reach a significant level by the end of 2012.