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FINANCIAL CHRONICLE™ » DAILY CHRONICLE™ » A year of uncertain economic fortunes

A year of uncertain economic fortunes

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1A year of uncertain economic fortunes Empty A year of uncertain economic fortunes Sun May 20, 2012 12:44 pm

CSE.SAS

CSE.SAS
Global Moderator
The one thing certain about this year’s economic performance is that it is uncertain. What is certain is that this year’s economic growth will be much lower than the growth of the last two years. The expected economic growth for 2012 is being revised downwards from time to time. The earlier expectation was that the 8 percent growth momentum would be maintained this year too. Soon after the dawn of this year the Central Bank revised it downwards to 7.2 percent. Other economists and analysts did not expect it to be as high. They placed the possible economic growth as being 6 to 6.5 percent.

The Central Bank is expected to announce a downward revision of economic growth owing to the poor performance of exports. The emerging global economic conditions suggest that the economy would grow by only around 6 percent. The Central Bank is likely to reduce the growth rate only slightly, perhaps to 7 percent.

The escalation of prices that has commenced would continue. This implies hardships for the poor and fixed income earners. Slow economic growth and high inflation is often characterized as stagflation. As yet one cannot characterize the emerging conditions as stagflation. It will be one of modest economic growth and high prices. Against all odds, the Central Bank is confident that inflation would be contained within single digit proportions at 7 percent this year. Whatever may be the statistic churned out about the rate of inflation, there can be no doubt that people are facing severe hardships with basic food and utility items rising. The escalation of prices is likely even without any more adverse developments.

External conditions
The external conditions and their impact on the external finances of the country are at the bottom of this story of hardships and lower economic growth. Equally true is the fact that the policy responses for the emerging balance of payments crisis were initially incorrect and the responses afterwards were too late. The depreciation of the currency, increased tariffs, higher interest rates and credit controls are expected to reduce the quantum of imports. As the balance of payments crisis worsens and global conditions are impacting adversely on exports, even this growth rate may be difficult to achieve.

The political developments in France and Greece are not propitious for economic stability and growth in the European Union. Some economists are of the view that instability in Europe would affect the US as well. In case this happens, the main markets for our industrial goods that are the US and EU countries would be seriously affected and our exports at risk. Already in the first two months industrial exports have increased by only 1 percent. Textile and garments exports have increased by only 1.5 percent. India and other Asian countries too are experiencing difficulties and their exports have fallen. If conditions worsen, then export earnings may even decline.

Compounding this are the events in the Middle East where the political turmoil affects our exports and imports adversely. On the export side the Middle East is a large market for tea. This includes Iran, Syria and the other countries in the region that are in turmoil. Developments in Iran have affected us adversely already and may affect us even more. The dislocation of trade with these countries has already had an adverse impact on tea exports. In the first two months of this year, earning from tea dropped by as much as 15.5 percent compared to tea exports during the same period last year. Consequently, agricultural export earnings declined by 11.3 percent.

The Central Bank has itself indicated that there would be downward revision of the expected growth rate owing to the unfavorable global conditions for our exports. If this trend in exports continues, the already strained trade balance would be adversely affected. Lower export growth implies slower economic growth, reduced incomes and possibility of unemployment. A further worsening of the trade deficit would be crippling. One can only hope for a turnaround in global conditions to benefit the economy.

Imports
On the import side, the international prices of oil matters much. International oil prices are very volatile. At the time of writing oil prices had dropped a little. There is no guarantee that oil prices would remain at around US$ 110 per barrel. If the situation flares up there is a possibility of oil prices skyrocketing. Already oil imports constitute 25 percent of import expenditure. It is an item of expenditure that weighs heavily on import expenditure and the trade balance. Therefore, a hike in oil prices would be of serious consequences to the already critical balance of payments. What could be hoped for is that international oil prices remain fairly stable and that there would be effective conservation measures to reign in consumption of petroleum products and electricity.

The good news is that already consumer imports have declined. In the first two months, consumer goods imports decreased by 2.2 percent compared to the first two months of 2011. This is the initial response to the higher prices owing to the higher tariffs and depreciation of the currency. These are only early signs that consumer imports would be reduced more during the year owing to the depreciation of the Rupee, tariff increases, higher interest rates and credit restrictions.

However, consumer imports account only for about 15 percent of import expenditure. The bigger outlay on imports is for intermediate and investment goods imports. Both these categories of imports have not still shown signs of decreases. Intermediate imports have increased by 22.2 percent and investment goods imports have risen by 57.2 percent during the first two months. Petroleum imports are expected to cost US$ 5.4 billion while investment goods imports are expected to cost US$ 5.6 billion this year. These targets of the Central Bank may be exceeded. Admittedly, constraining intermediate imports is difficult and could have an adverse impact on manufactures and exports. Yet, ways and means must be found to curtail intermediate and investment goods imports.

Remittances
It would be of serious consequence if employment possibilities in the Middle East are affected. In the first quarter of this year, the inflow of remittances has grown by 17 percent. The Central Bank expects an inflow of US$ 6.5 billion.

At present about 55 percent of the trade deficit is offset by remittances of workers and the main sources of these remittances are Middle Eastern countries. The increasing trend in remittances could be seriously thwarted by turmoil and even war in the Middle East. This would deny the country of a once thought of stable source of funding the trade deficit. The consequent balance of payments implications are severe. If remittances are unable to finance about half of the trade deficit then, a large balance of payments is likely.

Central Bank targets
The Central Bank expects imports to rise to US$ 20.9 billion while export earnings are expected to be US$ 11.7 billion. The US$ 9.2 billion is perhaps optimistic. It is likely to exceed US$ 10 billion. The trade deficit is expected to be offset by worker remittances, tourist earnings, foreign direct investment and other capital inflows. If the optimistic expectations are realized then there would be balance of payments surplus of about US $ 2 billion. It is more likely that the end result would be a larger trade deficit and lower capital inflows that would result in a balance of payments deficit of between US$ 1 to 2 billion.

Summing up
The fundamental reason for the current economic instability is the huge trade deficit that has caused a serious balance of payments problem. In this situation it is vital that import expenditures are drastically reduced. The increased tariffs, depreciation of the currency, higher domestic prices for imported commodities, higher interest rates and credit controls are expected to reduce the quantum of imports. The Central Bank is confident that import expenditure would be reduced in response to these measures. It is perhaps too early to expect the impact of these policies to be seen in the import statistics for the first two months, although, in fact, consumer goods imports decreased by 2.2 percent in the first two months.

This trend may continue in as far as consumer imports are concerned, but intermediate and capital goods imports have increased substantially and these matter much in containing the trade deficit. In a situation when global developments are unfavorable, it is important to ensure that the right policy responses contain the effects of the global downturn. Curtailment of government expenditure is vital to contain the trade deficit. As we pointed out last week it was commendable for the Treasury to be committed to not increasing government expenditure and to maintaining the fiscal deficit target under difficult circumstances. An economic recovery in the EU countries and the US would greatly assist the country’s economy.
http://www.nation.lk/edition/opinion/item/6210-a-year-of-uncertain-economic-fortunes.html

wgsaman

wgsaman
Senior Manager - Equity Analytics
Senior Manager - Equity Analytics
good work

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