The trade balance fell 4.1 percent to US$ 9.3 billion in 2012 after imports fell 5.8 percent to US$ 19 billion after authorities took a slew of measures in February 2012 to contain a balance of payments problem that was left to fester for more than six months.
However, the worrying factor in the trade account, despite the declining deficit, is that export earnings fell 7.4 percent to US$ 9.7 billion in 2012, from US$ 10.5 billion in 2011.
As a percentage of GDP, the country’s export earnings have been declining for over a decade.
Arguing the case for better fiscal management economists had argued that the link between fiscal policy and inadequate export growth became manifest in three ways; (a) large deficits crowd out private sector. (ii) borrowing from domestic sources raises the interest rate, encouraging inflows of portfolio capital and appreciates the exchange rate. (iii) inflation leads to demand for higher wages, import competing activities can pass on the cost increase to the domestic market, exporters facing world competition cannot raise price and triggers a decline in the export growth rate.
The relationship to monetary policy comes directly from the management of the exchange rate. Allowing inflation to take place (either through monetization of fiscal deficits or through private credit) lead to an appreciation of the exchange rate on the one hand and a rise in interest rates. And, when the Central Bank sold foreign exchange to the market to support the rupee, it lead to an involuntary open market operation since dollars are exchanged for rupees, leading to a reduction in liquidity in the domestic money market and a rise in interest rates.
Increased foreign borrowings coupled with the sterilization of inflows lead to higher interest rates where the economy is put on an unstable path by discouraging FDIs but encouraging short term capital flows or the carry trade. These have adverse repercussions on the rate of export growth, economists had argued at SLEA annual session last October.
The SLEA/OPA discussion under the theme ‘Sustained Economic Growth in the Midst of Widening Trade Deficit’ will feature the following speakers: Dr. Ajitha Tennakoon, Head of the Department of Economics, University of Kelaniya; Sarath Rajapatirana, Former Senior Adviser, The World Bank, Washington; Kulatunga Rajapakse, Managing Director, DSI Samson Group Pvt. Ltd, Dr. M. Z. M. Aazim, Deputy Director, Economic Research Department, Central Bank of Sri Lanka.
The discussion, open to the public, will be held on Friday, March 22 from 5pm onwards at the OPA auditorium at 275/75 Prof. Stanley Wijesundera Mawatha, Colombo 7.
The country’s export earnings which stood at 33 percent of GDP in 2000 have declined gradually over the years to 18 percent in 2011 and was estimated to have reached 15 percent of GDP in 2012. Imports too have declined but at a much slower pace from 44 percent of GDP in 2000 to 28 percent in 2012.
One of the speakers this Friday, told last year’s SLEA annual sessions that fiscal consolidation was imperative to create conditions for strong export growth and better resource allocation.
"The near term action must be on the expenditure side and raising the return to public expenditures and allowing headroom for private investment. We should use the 2003 budget balance legislation (Fiscal Management Responsibility Act) to implement fiscal consolidation," Sarath Rajapatirana, Former Senior Adviser, The World Bank, said.
"A flexible exchange rate policy would be helpful to raise competitiveness and export growth. One cannot say what level of the nominal exchange rate will prevail. It would depend on a host of factors including future supply and demand for foreign exchange, rate of domestic versus foreign rates of interests, net capital inflows and net access to Sri Lanka’s bond market. Make the exchange regime predictable and not try to fix it again around Rs. 125 a dollar by using reserves.
"Reduce barriers to FDI by improving the investment climate going beyond economic policies to issues of rule of law, protection of property rights and good governance. Get rid of the Termination of Employment of Workmen (special provision) Act No: 45 (1971) and Revival of Underperforming Enterprises and Underutilized Assets Act. (2011). Send a positive signal by these actions," Rajapatirana argued.
Published data suggests fiscal discipline was in disarray last year with the budget deficit reaching 6.4 percent of GDP by end September as against the full year target of 6.2 percent. According to the IMF, the government would be slightly off target after deferring capital expenditure and cash payments in favour of meeting recurrent expenditure.