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Mon, 20 April 2015 04:03:54
Sri Lanka current account in surplus amid economic slump
14 Dec, 2009 18:01:24
Dec 14, 2009 (LBO) - Sri Lanka's external current account is expected to swing into a surplus in 2009, for the first time since 1977, the central bank said, as the island was gripped by a severe trade contraction and economic slump.
In the first nine months of 2009, the current account was already in surplus by 393 million US dollars, the Central Bank said.

The current account is swinging back from a 3.7 billion dollar deficit in 2008, when Sri Lanka entered a balance of payments crisis. The island is prone to balance of payments crises since it follows a soft pegged exchange rate regime.

A steep contraction in the current account also occurred in the wake of a severe balance of payments crisis in 2001, when a deficit of 1,066 million US dollars in 2000, dwindled to just 215.1 million in the following year.

More Income

Sri Lanka started to register large and persistent trade deficits after 1977, when the economy was opened up and people went abroad for foreign jobs, increasing incomes.

Remittances started to increase the spending power of the people and capital inflows - especially foreign aid - also added to domestic purchasing power, driving import demand.

In Sri Lanka, the current account - especially imports via the trade account - is the key escape valve for foreign inflows as the capital account is restricted.

Money also flows out when the central bank sterilizes current inflows to build up foreign reserves, further restricting the spending power of the economy in the wake of a balance of payments crisis.

The central bank has locked up over five billion US dollars in reserves this year. Some were from the IMF and some were borrowed reserves directly swapped for government bonds, bypassing the domestic economy.

Empty Pockets

During and soon after a balance of payments crisis, imports collapse also because interest rates shoot up and banks are hit by liquidity shortages. This increases bad loans, banks restrict credit, slowing the economy and import demand.

It is also usual for the government to impose trade controls, in the form of punitive taxes, or additional margins for letters of credit amid a balance of payments crisis, until a float of the currency and International Monetary Fund help comes.

In 2009, however the demand for Sri Lanka's exports also crashed amid a global slump, further reducing the incomes and spending power in the domestic economy.

But credit growth and economic activity, is now starting to pick up.

The Central Bank has also said it was planning to relax capital controls.

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1. EconoCautious Dec 15
Here again, a wrong signal has been emitted because the current account surplus is only a temporary solace brought about by a faster contraction of imports, due mainly to a moderation in energy prices and a drastic decline in imports against a background of declining exports, may cause the authorities to postpone the much needed reforms.

A true and a sustainable improvement in the current account takes place either in an improvement in exports or an increase in the services income. The present current account surplus has been brought about by none, but a stable level of remittances which is again vulnerable to growth prospects in the Western world and the Middle East.

The complacence expressed is like a diabetic who, after seeing a blood sugar report taken just after an insulin injection, throws away his medicine kit.

The danger is, with the soft peg in force, the exchange rate becomes artificial and both exports and remittances get penalised, while imports and service payments get incentivised leading to a permanent BOP problem.