The external finances of the first four months of this year point to some favourable prospects as well as concerns and anxieties. While the balance of payments is likely to be in surplus this year, the trade balance is heading towards a large deficit owing to a continuing decline in export earnings. The current trend [...]


Are external finances improving or deteriorating?


The external finances of the first four months of this year point to some favourable prospects as well as concerns and anxieties.
While the balance of payments is likely to be in surplus this year, the trade balance is heading towards a large deficit owing to a continuing decline in export earnings.

The current trend in trade performance is likely to lead to a trade deficit of more than US$ 8.5 billion, only somewhat less than the deficits of the last two years. This has a decisive impact on incomes, employment and the structure and performance of the economy. On the other hand, the balance of payments is likely to be in surplus this year because of higher remittances, tourist earnings and earnings from other trade-in services, current transfers, and inflows to the financial account this year.

Trade deficit till April

Although the trade deficit in the first four months fell by as much as 14.6 per cent from US$ 3.47 billion to US$ 2.96 billion, it is still large and likely to result in a trade deficit of nearly US$ 9 billion, marginally lower than the deficits of US$ 9.7 billion and US$ 9.3 billion in 2011 and 2012, respectively. This reduction in the trade deficit by about 0.5 billion US dollars is due to import expenditure decreasing by US$ 764 million or 11.7 per cent in the first four months of this year compared to the same period last year.

However, the trend in the reduction of import expenditure in the first three months was reversed in April when expenditure on imports increased by 5.7 per cent due to all three categories of imports increasing. The import of consumer goods increased by as much as 12.7 per cent, while intermediate and investment goods imports increased by 5.5 and 1.2 per cent, respectively. If the increase in imports in April is a reversal of the earlier trend of declining imports, then the trade deficit could balloon to higher levels.

Export decline

The reduction in imports in the first four months by 11.2 per cent has been offset by a reduction of export earnings by 7.8 per cent from US$ 3.17 billion in 2012 to US$ 3.06 billion during the same period. More disconcerting than the overall decline in total export earnings is the drop in industrial export earnings by 7.8 per cent that has serious repercussions on incomes, employment and economic growth.

This is especially so as it is a trend that weakens the structure of the economy and its future growth potential.
The decline in export earnings by 6.8 per cent in April 2013 is a continuation of the declining trend in both agricultural and manufactured exports. Earnings from industrial exports declined in April 2013, with earnings from the country’s main manufactured export, garments, which account for more than a third of total exports, declining by nearly 15 per cent. The export of other industrial products, including processed food, beverages and tobacco; machinery and mechanical appliances and rubber products also declined.

The decline in agricultural exports was mostly due to a decline in rubber export earnings, again a trend decline attributed to the downturn in global economic activity.

Despite disruptions in some of the country’s main tea markets in the Middle East, tea export earnings, increased owing to favourable prices in the world market. However, there is concern of decreased tea production owing to structural weakness in the plantation sector. This is serious as tea is the main agricultural export and accounts for about 15 per cent of total export earnings.

Balance of payments

Despite these unfavourable trends in the trading account, the trade deficit of nearly US$ 9 billion this year is expected to be more than offset by workers’ remittances, tourist earnings, other service receipts, foreign investment in the stock market and foreign direct investment. Other capital inflows are also expected to increase and thereby result in a balance of payments surplus.
Workers remittances that have increased in past years increased by 6.4 per cent in the first four months and offset 71 per cent of the trade deficit. Remittances could be expected to contribute in like measure during the rest of the year and offset more than 70 per cent of a likely trade deficit of US$ 8.5 billion to 9 billion.

Tourist earnings too have increased significantly by nearly 20 per cent and brought in US$ 407 million in the first four months. Tourist earnings are less certain than remittances as there are several concerns about the political situation and law and order and high cost of accommodation. On the other hand, the Commonwealth Heads of Government Meeting may attract an inflow of foreigners who would swell foreign exchange earnings. It is quite realistic to expect tourist earnings to reach about 1.3 billion at yearend. Therefore workers’ remittances and tourist earnings are likely to offset most of the trade deficit. 0ther capital inflows should result in a balance of payments surplus of about 1.5 billion.

Critical issues

Despite a likely balance of payments surplus there are serious concerns in the country’s external finances that leave no room for complacency. A balance of payments surplus achieved with a huge trade deficit is indicative of a weak economy. Export earnings, which continue to be only about one half of the expenditure on imports, reflect structural weaknesses in the economy. Furthermore exports are continuing to decline.

The fall in manufactured exports by nearly 8 per cent is a threat to the country’s export industries, employment and incomes. Economic growth must be achieved through higher industrial output that is hardly possible when export industries are faring badly.
Although the declining trend in import expenditure was of relief to the trade deficit, the increase in all categories of imports in April is apprehensive. In a situation when export earnings are declining, the country cannot afford to import more and thereby widen the trade gap. Policy measures are needed to curtail imports of all three categories of imports, as a resurgence of exports is unlikely this year.

The long term strategy to strengthen the trade balance is to increase exports significantly. It is unsatisfactory to interpret the dip in exports as entirely due to falling external demand. The lack of adequate exportable surpluses, the high costs of production and low productivity are fundamental reasons for the poor export performance. The need to orient the country’s foreign policy towards countries that matter for our trade relations is also vital.

The withdrawal of the GSP plus status in the European Union is no doubt one of the reasons for the country’s lesser competitiveness of manufactured exports to Europe that is a sizeable market for these goods.

The prospect of a balance of payments surplus should not lead to complacency about correcting the trade imbalance. Policies must be geared to improving the investment climate, decreasing costs of production, enhancing productivity and improving of trade relations with countries that matter. The persistent large trade deficits are a threat to economic stability and long-term growth.

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