The Sunday Times Economic Analysis

The Sunday Times Economic Analysis By the Economist

Responding to the crisis judiciously essential
It is vital that the government does not panic in the face of the current economic crisis and respond in a manner that could worsen the balance of payments problem. A proper assessment of the nature of the crisis and a judicious and balanced response to it is essential to avoid deterioration in the country's economic conditions.

The economic crisis as a consequence of the oil price hike has many dimensions. It is leading to a huge trade deficit that could pose problems to the balance of payments and is already weakening the rupee. The resultant high costs of oil and other imports are leading to an inflationary spiral. The subsidisation of some prices is a strain on already weak public finances.

In such a context the response to the problems created could worsen the problem and lead to diverse ramifications. It must be recognised that the oil price hike might continue for some time and many international prices, especially of vital intermediate goods and some finished goods would rise. There is little we can do about international prices of commodities but the nature of response to the crisis could either contain the ill effects or amplify its ramifications.

The government's efforts to use the country's goodwill with oil exporting countries to obtain deferred payments for oil purchases or a loan facility may give us a respite but not a solution. Even these are doubtful and in any case would be a mere postponement of the problem.

In as far as the balance of payments problem is concerned, the current level of foreign exchange reserves of around US $ 3000 million could help us tide over the immediate foreign exchange problem. Besides, earnings from services and foreign remittances from Sri Lankans abroad would reduce the adverse impact.

Nevertheless there is an emerging foreign exchange problem that must not be allowed to get out of hand. The IMF has a responsibility to assist the country in the face of this crisis. The support to countries when they face sudden rises in international prices is a prime responsibility of the IMF. Therefore the government could get some financial support to tide over the balance of payments crisis.

This assistance is different from the IMF assistance under the Structural Adjustment or Extended Structural Adjustment facilities. They should not have conditionalities that require policy changes and therefore easier for the country to obtain them.

There is a need to ensure that in the light of the rise in prices that we curtail consumption of non-essential imports so as to reduce to some extent the expenditure on oil and other imports. This has to be done judiciously. The curtailment of expenditure should be in consumption areas and not in the use of oil in industry, especially export industries.

In the case of export industries it should be possible to pass on the oil price increases to the consumers abroad, as it is a worldwide development. The rise in oil prices should not be allowed to retard the wheels of industry. On the other hand, the government's initial response of cushioning consumers through government subsidy was bad economic policy, as it postponed consumers' adjustment to the new prices.

The demand for the higher priced petroleum was not reduced, as domestic prices did not reflect the new increases in import costs. Therefore the country has tended to aggravate the problem by not curtailing consumption of oil.

Such subsidisation also meant that the budget deficit could grow and create macroeconomic problems such as curtailment of development expenditures, increase in interest rates and inflationary sources of funding the increased deficit.

In facing the crisis the government must bear in mind that the country would also have certain gains from the oil price hike. These would not offset the problem completely but give some relief. Some of the country's exports are likely to fetch higher prices. The oil price increase by increasing the cost of production of synthetic rubber would cause a rise in natural rubber prices too. The increased incomes in petroleum producing countries could lead to an increased demand for tea that would raise prices.

With higher incomes employment possibilities in the Middle East may also increase. However these benefits would take time and are unlikely to offset the adverse impacts substantially.

Nevertheless they are bound to help the country's balance of payments later. In contrast, if the oil price rise continues, there is a prospect of a slow down in the global economy. This would hurt our industrial exports and tourism.

The dangerous scenario is for the government to embark on controlling the economy, particularly foreign exchange transactions. There are enough experiences from the past that show clearly that attempts to control the economy could aggravate the balance of payments crisis through capital flight and reduced inward remittances for exports. It is not only actual policy changes, but also pronouncements of intended controls, that could hurt the economy.

It is therefore important that the constituent elements of the government understand the nature of the problem and responds appropriately. Panic-driven statements can hurt the country's economy.

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