The Sunday Times Economic Analysis                 By the Economist  

Are we heading for a balance of payment crisis?
The trade deficit continues to increase this year. In the first quarter of this year, in spite of an increase in exports by 14 percent, the trade deficit rose to a huge US $ 465 million. This deficit was three and a half times the deficit in the first quarter of last year, when it was US$ 129 million.

If the trade deficit continues to increase in this manner the end year position could be a colossal deficit. This would be a severe strain on the balance of payments and drain the country's foreign exchange reserves.

Although the country has had trade deficits every year since 1978, the deficits of the past three years have not been of much concern, as these have been more than offset by capital movements. In the last three years, there have been balance of payments surpluses. The country had trade deficits of US $ millions 1157, 1406 and 1539 in 2001, 2002 and 2003, respectively. There were also current account deficits in all three years, but in each of these years the overall balance was a surplus.

The overall surpluses in the balance of payments were US$ millions 220 (2001), 328 (2002) and 502 (2003). As a result foreign exchange reserves continued to increase. At the end of last year they were US$ 3218 million, compared to US$ 2131 million at the end of 2000. By the end of March external assets had risen further to US $ 3313 million. Therefore the external reserves are in a position to face a huge balance of payments deficit but the reserves would dwindle and create problems for the future.

The current developments are likely to weaken the reserve position. The increase in the price of imports especially the price of oil that has risen sharply from that of last year, the increase in the price of fertiliser, in particular, and other intermediate goods are likely to increase import values and thereby widen the trade deficit. The indications are that capital inflows would also slacken. This is especially so with respect to official inflows that are linked to the peace process. Further the assistance of the multilateral agencies would be given only once the government's economic policies are made clear and are acceptable to them.

The assistance from the IMF, World Bank and ADB carry conditions that appear to be difficult to fulfil. Therein lies the problem. Export earnings are likely to continue its up-trend unless the oil price hike causes another global recession. Industrial exports increased by 13 per cent and agricultural exports by 24.5 per cent in the first three months. The increase in the exports of garments, the country's largest export item, was however a modest 9.4 per cent. The global economic recovery is likely to accentuate this trend in industrial exports. Tea exports are likely to increase from that of last year owing to an increase in tea production and an improvement in prices.

The difficulties are on the import side. So far imports have shown an increase and thereby widened the deficit and strained the balance of trade. It is generally argued that the increase in imports reflects an increase in intermediate and capital imports and indicates a trend in Industrial production. The increase in intermediate goods imports has been higher than that of consumer goods. While intermediate goods imports increased by 13.4 percent, consumer goods imports increased by only 3.5 per cent. However it must be realised that the most important item among intermediate imports is petroleum.

And oil prices are sky rocketing. The government absorbing this price increases without passing them to consumers means that there would not be a consumer curtailment of demand. There was a massive increase in investment goods of 45 per cent.

A Balance of Payments crisis is certainly most likely this year. The prospects for the remaining months are bleak. The factors that have been favourable so far are likely to reverse, while the unfavourable trends witnessed in recent months are likely to continue. Unfortunately the trends in the international economy and the chaotic conditions in the country, are likely to bring about serious strains in the balance of payments. There is no doubt that the country is in dire need of foreign assistance to tide over its balance of payments difficulties.

The question is whether such assistance would be forthcoming owing to the political uncertainties, stalling of the peace process and their implications for the economy? Is there recognition of the impending difficulties?

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