Global economic conditions will determine to a large extent Sri Lanka's economic performance in 2012. Although global economic developments are beyond the country's control, appropriate responses could mitigate their adverse impacts.
However, more important than the country's short-term economic performance is the longer view of the country's development policies to ensure healthy economic development. A longer-term perspective rather than immediate concerns is vital.
The long-term perspective should put in place policies that would ensure sustained economic development. These include good fiscal, monetary and exchange-rate policies, certainty and predictability of economic policies, political stability, good governance, the rule of law, guarantee of property rights and, most importantly, a permanent political solution to the grievances of the people in the North and East.
Nonetheless current decisions on economic policies have an important influence on the course of economic development. First, we review current economic prospects and then discuss the needed policy directions for sustained economic development.
Prospects for economic growth this year are not bright, as global economic developments pose serious threats to the country's economic performance.
The most significant factor is the slowdown of economic development in the West. The United States is still unable to recover sufficiently from recessionary conditions and likely to grow at a slow pace of around 1 per cent and unemployment remains high.
Most European Union countries are in a state of economic confusion and a currency crisis. Early resolution of these problems is improbable.
The sluggish economic conditions in the United States and Europe will have serious repercussions on the country's exports, as it is these Western countries that import a large proportion of the country's exports, especially manufactured goods.
In 2010 Europe and North America accounted for 56 per cent of the country's exports, with the United States accounting for 21.1 percent and EU countries being the destination for 35 percent of exports. Furthermore, the flow of remittances from Western countries that are quite significant could also be affected by the slow economic growth in the West. The slack in demand of these countries is not likely to be taken by Asian markets that more or less export the same types of commodities.
All Asian countries accounted for only 16 percent of exports in 2010. They are competitors rather than markets for Sri Lankan manufactured products. Furthermore, economic development in India and China are likely to slow down. In fact, these economies are attempting to restrain their high growth as their economies are overheated and likely to experience high rates of inflation.
The turmoil in the Middle East constitutes another unfavourable development. This is especially so with respect to tea, the country's main agricultural export. The chaos in the Middle East is reducing the demand for tea whose prices have fallen recently. The disruption in Middle Eastern countries would also affect migration of workers to these countries and reduce remittances in due course.
The high prices of oil are another threat to the economy. The massive trade deficit of US$ 7.7 billion in the first ten months is mostly due to the increase in imports by 50 per cent in 2011 over the amount in 2010. About 25 per cent of import expenditure last year was on petroleum imports.
The increase in import expenditure of oil last year was mainly due to higher prices, though increases in consumption too aggravated the problem. High oil prices coupled with continuous increases in oil consumption is likely to create the same sort of trade deficit this year too, unless measures are taken to curtail oil consumption. Such a massive trade deficit would be a serious threat to the balance of payments. Further, foreign borrowing to counteract diminishing reserves could create problems for the future.
These external conditions cannot be controlled by Sri Lanka. We could only take some counter measures to reduce the impact of these external shocks. One of the suggested policies recently is that we should diversify the direction of our trade to export more to Asian countries. However, the possibility of expanding trade in the region is somewhat limited by the fact that most of the country's exports are produced in those countries as well. For instance, India and China are the two largest producers of tea.
There is a demand for rubber from China, as has been the case for the last five decades. However, the exportable surplus of rubber is limited both owing to supply inelasticity and due to most rubber produced being used by domestic industry for manufacture of rubber-based exports. Other manufactures such as garments are also export items of China, India, Vietnam, Bangladesh and other counties in the region.
While every effort must be taken to increase exports to the region, there is no huge potential due to these reasons. In this situation, it is important to maintain good relations with our major exporting countries. Better diplomatic relations based on pragmatic economic considerations should determine our foreign policies with the US and European countries. Better relations with them could help improve trading relations and even obtain concessionary tariff concessions.
The diversification of the composition of exports is the other strategy that needs to be pursued. There has been a significant diversification of exports since the initial huge dependence on exports of garments. Currently, garments exports account for only 51 per cent of industrial exports. Other exports include rubber based products like gloves and tyres, leather products, ceramics, electrical accessories, boats and processed foods. Rubber manufactures account for 11 per cent of industrial exports.
Information technology has provided a new avenue of exports. Earnings from information communications technology (ICT) services shot up 47 per cent to US dollars 310 million in 2010-11. These services that have 175 firms employing 16,000 persons have a good potential to grow. There is an expectation that these export earnings could reach a billion US dollars by 2015. Export of such services provides a means of stabilising and increasing export earnings. The progressive diversification of exports with an emphasis on higher value added products must be an objective of government policy.
The development of a hospitable business climate is the vital need at present. Last year witnessed a setback to business confidence by the passage of the Revival of Underperforming Enterprises and Underutilized Assets Act: more popularly and perhaps appropriately known as the business takeover or expropriation act. This has added a high degree of insecurity to private investment.
The government's realisation that this act is a serious setback to foreign investment has led to statements that this Act will not be used to acquire any more businesses. Such assurances are not likely to inspire business confidence when there is an Act in the statute book that permits the government to take over private business arbitrarily under the vague and undefined notion of underperforming or underutilising.
The damage has already been done and international ratings would place the country as a risky destination for foreign investment. Fretting or fussing over such ratings does little good. More drastic measures to reverse this erosion of business confidence are needed if the country is to benefit from higher levels of foreign and domestic investment that are undeniably needed to maintain a high trajectory of economic growth, generate employment, enhance income levels and alleviate poverty.
Healthy macroeconomic fundamentals are vital to ensure economic stability and growth. A manageable level of the fiscal deficit is fundamental and critical towards this end. Fortunately there has been a declining fiscal deficit and a movement towards fiscal consolidation.
Further fiscal consolidation should be achieved by increasing tax revenue, spending more on developmental expenditure, economic and social infrastructure and reducing wasteful expenditure and subsidies to loss making public enterprises. The fiscal outturn alone is not adequate to provide the correct fiscal incentives for development: prioritisation of expenditure for the developmental needs is as important.
The rising public debt, especially the increasing foreign debt and debt servicing costs need to be curtailed to provide economic stability. The widening trade deficit that could reach US$ 9 billion in 2011 would strain the balance of payments and erode foreign exchange reserves much of which have been borrowed at high cost from commercial sources. Improvements in these areas are needed to ensure economic stability, attract foreign investment and generate economic growth.
Reconciliation and good governance
Despite the end of the war two and a half years ago, there has been inadequate progress towards national consolidation. The inability to forge a satisfactory settlement casts doubts about the durability of the peace. A political solution to the satisfaction of all communities - a solution that will make ethnic conflicts a thing of the past -- is vital for robust economic growth.
It is as important to ensure the rule of law, law and order and property rights. These elements of good governance are fundamental prerequisites for rapid economic growth. History has amply demonstrated that peace, political stability and law and order are vital perquisites for development. This is more so today when there is global interdependence and the foreign perception of a country are important for foreign investment, trade and international economic relations.
The year ahead is one in which the economy would face serious difficulties. While these must be overcome with countervailing policies, the government must have an eye on the preconditions for long term economic development.
A multiplicity of conditions has to be satisfied to enable long term sustained economic development. Unless these conditions are fulfilled there would be only spurts of economic growth. Even these could be threatened by external and internal shocks.