Increasing debt, high prices and deceleration

~ Summing up 2007:

By the Economist

The economic performance of 2007 has been characterised by very high inflation, the rise in the public debt and foreign debt, depreciation of the currency, massive increase in military expenditure and a slowing down of economic growth. It was also a year of political controversy centred around two economic issues. The foreign bond issue of US $ 500 million and the voting of the Budget for 2008 took centre stage in political debate for a few weeks.

While the government claims it is a year of economic achievement, the burdens of high prices in particular, have generated scepticism about the year's economic achievements. The economic growth for the year is likely to be one percentage point lower than that of 2006 according to the Central Bank. In fact it may be much lower in the region of 6 percent compared to the 7.7 percent growth in 2006. This decelerating trend coupled with the macroeconomic imbalances portends a further slowing down of the economy in the months ahead.

At the end of the year prices have climbed about 25 percent higher than it was a year ago. The end November increase in prices was 24 percent compared to prices 12 months before. A feature of price behaviour this year was that the double digit inflation gained momentum since the middle of the year. Many of the rapid rises in prices were in basic commodities of consumption led by the increase in prices of import commodities such as wheat flour and bread, milk powder, sugar, lentils, gas, petroleum and transport prices. Domestic commodities too rose in price. Among the large increases in prices were the price of rice and vegetables. In fact prices of nearly all basic food items increased so sharply that the lower income groups and fixed income earners suffered a severe beating in their living standards. Public servants, estate workers and some private sector employees were compensated to an extent by increases in wages. However, the escalating prices would have more than offset any immediate compensation that they received. The rest of the population had to face the sharp increases in prices without any such cushioning.

The country's public debt rose to nearly Rs 3000 billion. At the end of this year the public debt might even exceed the GDP for 2007. The public debt increased by 14 percent in the first nine months of the year from Rs. 2606 billion at the end of last year to Rs. 2978 billion at the end of September. In the last twelve months, from September of last year to this September, the public debt increased by as much as 22 percent. The increase in the debt was brought about by an increase in both domestic and foreign borrowing. The foreign debt had risen by about 27 percent in 12 months to nearly Rs. 3000 billion at the end of September this year. The domestic debt had increased by about 14 percent during the first ten months of the year while the foreign debt had increased by nearly 15 percent during the same period. The disadvantage of the rise in public debt is that debt serving costs have risen to a high proportion of government revenue. This has been one of the factors that distorted public expenditure as well as increased the budget deficit.

The new borrowing from abroad, mainly the bond issue of US$ 500 million, raised a hue and cry from the Opposition. Many economists and financial experts thought the government should not have borrowed such a large sum. The criticism was due to not only the large amount of borrowing but also due to it being a commercial loan at an interest rate of 8.25 percent repayable in a single bullet in the fifth year. This, it was argued, would place a heavy burden on the public finances and the balance of payments in five years' time. Further, there is much doubt that the proceeds of the foreign loans would be spent on avenues that would generate goods and services that are exportable or those that would reduce imports. This is the most pertinent issue in the controversy as the debt servicing costs could become burdensome owing to the unproductive uses of the loan.

The trade deficit this year too is very high and would exceed US $ 3000 million. It is likely to be slightly lower than that of last year as the trade gap is running at about 7 percent lower in the first nine months of the year. In spite of this large trade deficit, the country is expected to register a balance of payments surplus for the third successive year mainly owing to foreign borrowing and an increase in remittances from nationals abroad.

The foreign exchange reserves are running high at US $ 4500 million at the end of October mainly due to foreign borrowing and other capital inflows. This reserve is the equivalent of 5 months of estimated imports.

Despite these developments in the country's debt situation, the high rate of inflation, large trade deficit and the depreciating currency, the government takes refuge in the economic growth rate that is considered quite an achievement. According to the calculations of the Department of Census and Statistics, the economy is expected to register a growth of 6.7 percent in 2007, one percentage point less than that of last year. Whether this would in fact be realised is to be seen as the calculation may not have taken into consideration some of the unfavourable impacts on the economy in the fourth quarter of the year, particularly the high rate of inflation and the tight monetary policy that is being pursued to combat it. However, even a somewhat lower growth of 6 percent would be interpreted in the same light as a good achievement in the face of international economic challenges and the on going war.

The debatable question is whether the deceleration in growth is a sign of the impact of macroeconomic weaknesses and whether these would affect the competitiveness of the country's exports on which the economy rests heavily. The most serious issue is that the government appears to be oblivious of the fundamental weaknesses in the economy and is not sensitive to the need for economic and fiscal reform measures that alone can bring the economy into a path of rapid economic growth. Will the adverse developments in the economy in the year that is ending have a serious setback to the economy next year?