The Sunday Times Economic Analysis

Remittances from abroad conceal balance of payment problems
In his forthcoming book “Contemporary Economic Issues: Sri Lanka in the Global Context,” Dr. Saman Kelegama identified the twin problems of the external imbalance and the recurring high fiscal deficits to be the core issues in economic management.

His essay on the "New Dimensions in Macroeconomic Management," in this volume makes this important point. In Kelegama's words, "Managing the macro-economy with twin deficits in both the external and domestic current accounts is becoming increasingly complex."

Are we facing these fundamental economic problems or are we postponing their resolution with short-term palliatives that could aggravate them?
Since 1978 the country sustained a continuous trade deficit. For the last 27 years the country has had trade deficits that have grown rather than diminished. Last year's trade deficit of US $ 2.5 billion was the highest ever and increase in costs of petroleum imports was the main reason for this.

The petroleum import bill increased by 37 percent to US dollars 1,655 million in 2005 due to an increase in prices of a similar dimension. Consequently the trade deficit increased to US dollars 2,516 million. However the current account deficit increased by only 650 million US dollars. Therefore the massive trade deficit did not lead to a huge current account deficit in the balance of payments. Why?

It is well known that remittances of Sri Lankan workers abroad have been an important support for balance of payments for nearly two decades. Last year saw an increased inflow according to the Central Bank worker remittances, which grew by 22.7 percent last year to 1,918 million US dollars. The significance of these remittances becomes even clearer when one realises that they cover as much as 75 percent of the trade deficit. Consequently, the current account deficit declined from 3.2percent of GDP, in 2004 to 2.8 percent in 2005.

However it’s observed that these inflows are not entirely from workers in the Middle Eastern countries, as is often assumed. According to the 2005 Central Bank Annual Report statistics, only 56.8 percent of the inflows were from Middle Eastern countries. The rest were from nearly all regions of the world. European Union countries accounted for 18.5 percent of them.

A significant proportion of these remittances come from other countries as well, from professionals working in Europe, US, Canada and African countries. Some of these remittances may have been used to buy properties in prime locations as holiday homes of the affluent Sri Lankan dual citizens.

The other relief was from Tsunami rehabilitation funds. These too came to the rescue of the balance of payments. Net inflows of funds to the government increased by as much as 91.5 per cent in 2005. These were almost entirely the large tsunami aid from governments and aid agencies.
The balance of payments also benefited by lower debt repayments owing to the debt moratoria from several governments. In addition the strain on the balance of payments was temporarily eased by lines of credit for oil purchases from Iran and India totalling US$ 250 million.

These fortuitous developments resulted in an overall balance of payments surplus of US dollars 501 million. This surplus raised the official external reserves to 2,735 million US dollars that were adequate to finance 3.7 months of imports, according to Central Bank estimates. It also led to a modest appreciation of the rupee against major currencies.

This in turn resulted in a revaluation of the foreign debt component and the public debt GDP ratio falling from over 100 percent to 96.5percent of GDP in 2005. Ironically, last year's balance of payments averted a crisis by the financial fall out from a natural disaster. This could lead to complacency resulting in not taking remedial measures to resolve fundamental problems. The seriousness of the continuing oil price increases remains unfelt due to these other financial inflows from abroad. There are therefore inadequate adjustments being made by consumers owing to the price increases not being passed on fully.

The efforts to enhance energy supplies have also been inadequate. The story that Sri Lanka would have its own supply of oil in a few years lulls us into greater complacency.

Considering the fact that we have heard the story of offshore oil many times in the past, it may be sensible to take the news of the availability of oil with a pinch of salt. International oil prices are on an upward trend and cannot be expected to decline though a few fluctuations would occur both upward and downward owing to political factors like the current Iranian nuclear issue.

The continuous rise in oil prices is cancerous; it will eat into our costs of production and contribute to inflation. Our exports could suffer while domestic production of many goods and services including agricultural output could suffer too as higher costs of petroleum-based fertiliser and chemicals would raise production costs or reduce agricultural output.

Currently petroleum imports account for 18.7 per cent of the total import bill, while imports of fertiliser and chemicals constitute 5.3 per cent of the import costs. Curtailing these expenditures is not easy. Last year petroleum imports were reduced by nearly 9 percent, but the expenditure on petroleum imports rose by 37 per cent.

There are difficulties in curtailing the volume of imports, while prices are continuously escalating. That is the chronic problem we have to face in the years ahead.

Unless we recognise the seriousness of the balance of payments problem and its impact on future growth, the responses could be inadequate. Preoccupation with security and the complacency generated by last year's fortuitous financial developments could lead us to a crisis of serious proportions in the near future.