Columns - The Sunday Times Economic Analysis

Mind the gap: The trade deficit is ballooning

By the Economist

The external trade statistics for the first two months of this year indicate a deteriorating trade performance. The trade deficit has grown by a mammoth 277 per cent or over two and half times in comparison with that of the first two months of last year. In just two months the deficit has ballooned to US $ 1033.4 million. If this trend continues then the trade gap would reach around US$ 6000 million. It could be higher if import prices, especially of oil increases.

It is difficult to understand how this trade performance could be evaluated by the Central Bank as a favourable development. In the assessment of the Central Bank: “Sri Lanka’s external sector performance showed signs of improvement along with the gradual recovery of the global economy.” Although there are some positive signs these are more than offset by the negative developments in trade. If truth be told, the developing external trade picture is one of serious concern and apprehension.

The reason behind the Central Bank statement is presumably because “Earnings from exports grew by 20.0 per cent in February 2010 to US dollars 629 million led by higher earnings from agricultural and industrial exports.” However, as the Central Bank itself notes, “The expenditure on imports also increased by 60.6 per cent to US dollars 973 million, due to the increased demand for imports within all the sub sectors.” In brief, although earnings from exports grew, the growth in import expenditure totally eroded this benefit, leading to an increase in the trade deficit. Even with the growth in export earnings in February, the trade deficit swelled to US dollars 344 million for the single month.

The positive development was the increase in export earnings by as much as 20 per cent in February this year. Earnings from agricultural exports increased by 97 per cent in February and by 49 per cent in the first two months mainly due to higher international prices for tea, rubber and other agricultural exports like fruits. In the case of tea, the main agricultural export, prices increased by 25.7 per cent to US dollars 4.35 per kg mainly due to the better quality of tea exports and supply shortages in the international market. Similarly, rubber prices increased to US dollars 2.86 per kg, a 95.4 per cent increase compared to February 2009.

This sharp increase in rubber prices according to the Central Bank was mainly due to an increase in international demand and supply shortages due to the adverse weather conditions in major rubber producing countries in Asia. According to the Central Bank earnings from minor agricultural exports also increased due to “higher prices fetched by fruits, coffee, and cocoa products and increased volumes of vegetables, areca nuts, cashew and essential oils. Export earnings from certain spices such as cinnamon and cloves increased led by higher volumes and prices.”

The problem of the increasing trade deficit has been masked by the figures of these improvements in exports in February. However the improvement was in February alone. The increase in export earnings in the first two months was only 8.4 per cent quite inadequate to cope with the substantial increase in import expenditure. Even in February, the export earnings fell far short of the import expenditure and in the single month of February the trade deficit was a huge US $ 344.5 million. Even a projection of this figure for the year indicates that the trade gap would be around US$ 4000. For the trade deficit to be contained at this level export earnings would have to increase by 20 per cent, as achieved in February, and import expenditure should not increase further than the February growth rate.

The performance in industrial exports over the last two years has been a matter of serious concern not merely due to its poor performance impacting adversely on the trade balance, but due to the shrinkage in industrial exports causing shut downs in manufacturing plants. It is estimated that around 100,000 jobs have been lost in the textile and garments sector, owing to the closure of garment factories. The loss in industrial exports is mostly attributed to the global economic recession. In fact other factors have also been responsible for the loss of markets. The increasing costs of production and exchange rate policy have been among these reasons. The withdrawal of the GSP+ status by the EU has affected exports to European Union countries, the country’s most important market.

Although industrial exports increased by 11 per cent in February from that of January, industrial exports declined by 2.5 per cent in the first two months of the year. Significantly, textile and garments and ceramic products declined in February 2010. Textiles and garments exports declined in February by 9.7 per cent and in the first two months by as much as 18.1 per cent. In the light of this evidence we can hardly celebrate with the ever optimistic assertion of the Central Bank that “The industrial exports, which were affected by the global economic crisis, rebounded in February 2010, led by the exports of processed food and beverages as well as rubber products.”

Unlike last year when the trade deficit was completely offset by inward remittances, the increasing trade deficit of this year is unlikely to be wiped out by worker remittances. In fact the trade deficit of the first two months of this year of US$ 1034 million is much higher than the amount of remittances.

Worker remittances amounted to only 55 per cent of the trade deficit in the first two months. With the growing trade gap, even the increasing worker remittances at around 13 per cent are not likely to offset the trade deficit. Therefore it is likely that the country would face a huge trade deficit as well as a significant current account deficit in the trade balance.

This implies a strain in the balance of payments that may have to be offset by a decline in the country’s reserves, unless capital inflows in the form of aid, portfolio investments and foreign direct investments are large enough to compensate for the deficit in the current account of the balance of trade. The other expectation is that tourist earnings would be substantial and would be higher than the trade deficit.

The plain truth is that the country is heading for a huge trade deficit this year. It is important to recognize this and its implications for the balance of payments. Celebrating an export growth of 20 per `cent in a single month is hardly the way to face the emerging crisis.

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