The Sunday Times Economic Analysis

The Sunday Times Economic Analysis By the Economist

Foreign aid to tide over oil price crisis?
The oil price hike is making a dent in the foreign reserves and a balance of payments crisis is on the cards. In this situation it is not surprising that the government has been exploring the possibility of obtaining a credit line for the import of crude oil. It is no surprise either that they should turn to the Organisation of Petroleum Exporting Countries (OPEC) consortium, and specifically to Saudi Arabia, where the extra petro dollars are being stacked.

If the government succeeds then the balance of payments difficulties would be abated. The extent of such assistance would matter. If it could cover the extra costs incurred this year compared to that of last year then it would be a welcome relief.

However, the terms and conditions of any facility would be germane. If it is without interest costs then there is a definite gain. If, on the other hand, it is obtained at international lending rates, then it would be tantamount to a loan at commercial interest rates. It would increase the foreign debt burden and the foreign debt-servicing ratio would rise. The latter is the ratio of debt repayment and servicing costs as a proportion of export earnings.

It measures the extent of the burden in terms of the capacity to service it through export earnings. Sometimes the calculation includes in its denominator the remittances of nationals from abroad as well, as these constitute a very significant proportion of several countries balance of payments. This is the case in Sri Lanka as well.

Hitherto, foreign debt has been fairly prudently managed with commercial borrowings kept to a low proportion of total borrowings.The country has relied mainly on foreign loans on concessional terms with low interest rates and long periods of repayment.

Consequently the foreign debt service ratio was only 11.6 per cent of export earnings and only 9.3 of total receipts. In other words the costs of servicing the foreign debt from export earnings and remittances was less than 10 per cent. Nevertheless the foreign debt is an important component of the public debt. At the end of last year it was about 45 per cent of the public debt and readers are aware that the public debt is higher than the values of goods and services produced during the year, about 105 per cent of GDP.

The foreign debt was 47.9 per cent of GDP last year. The implication of this is that while foreign assistance through a loan facility could relieve the balance of payments problem and may be a dire need in the current context, it would add to the burden of debt in the country, both the national debt burden as well as foreign debt servicing costs. Such assistance is essentially the deferring of the country's difficulties: a postponement of the problems caused by the oil price hike.

There is another important implication and danger of obtaining a loan that must be recognised and responded to. A loan facility may lead to complacency as if the problems created by the oil price rise have been averted. This complacency could lead to domestic prices of petroleum-based products not being revised upwards in line with international prices.

If this were to happen then the expenditure on crude oil imports would continue to rise. The government is of course on the horns of a dilemma. If the prices are raised adequately there may be a curtailment of demand. Yet the cost of living would rise further. Such inflationary pressures would eat into the competitiveness of our export industrial products, as well as be politically unpalatable.

Unfortunately voluntary curtailment of demand is an impractical measure. Even a price increase for petroleum-based products does not appear to reduce demand significantly. Innovative pricing polices are needed. These should attempt to curtail consumption of oil-based products, including electricity, without either burdening the poor excessively or increasing the costs of production of goods. Increased pricing should be complemented with a public awareness of the need to conserve consumption.

The dangers of unrestricted consumption of petroleum, diesel, electricity and other oil-based products must be explained. The policies to curtail demand must not rely on bureaucratic controls that tend to be ineffective with innovative corruption practices. An example must be set by the highest personalities in the country and public officers.

When the oil price crisis occurred in the 1970's the President of the United States turned down the heating at the White House and wore several sweaters to cope with the cold weather. Such is the type of example needed when a poor country like ours faces an onslaught of serious proportions from the global market place.

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