Interview: Sri Lanka BOP pressured by consumer spending, external woes

Exports

Aug 28, 2015 (LBO) – Post-war stimulus packages by Sri Lanka’s government have pushed up consumption demand which is now having an adverse impact on the trade deficit and balance of payments. This is one reason for the negative BOP position so far this year, Shiran Fernando at Frontier Research said.

“We are in consumption overdrive. Fiscally you had two budgets full of stimulus that increased purchasing power of consumers,” Fernando told Lanka Business Online.

“We had two cycles of consumption booms, of which we are currently in one.”

The trade deficit during the first six months of 2015 increased to four billion dollars from 3.5 billion dollars in the corresponding period of last year, a deficit which an exporter nation can ill afford. This was propelled in part by imports of vehicles for personal use, up 110 percent, and imports for business use, up 238 percent, in June, which includes trishaws.

“We have seen vehicle imports picking up, consumer goods picking up. All this is impacting on the balance of payments,” Fernando, an economic and equity researcher, said.

Although measures to streamline imports of vehicles, promote import substitution and improve public transportation would be the way to go, Sri Lankans seem to be addicted to their vehicles. Any measures to discourage such imports would be unpopular, especially during an election year.

Remittances from Sri Lankan workers abroad usually helps to bridge this trade deficit. However, worker remittances were up just 2.2 percent to 3.43 billion dollars in the first half.

“This could be due to Middle East issues. If you look at the third biggest departure market UAE, they are having a contraction in job hiring as well,” he said.

A cyclical downturn in the financial account along with lower exports of garments and tea has turned a balance of payments surplus into a deficit. A surplus of 1.9 billion dollars, during the first half of last year,  is now a deficit of 791 million dollars.

“Sri Lanka is precariously placed because of domestic and external factors. Emerging market economies have had anemic growth, so they have been devaluing their currencies,” Fernando said.

Sri Lanka reserves Frontier Research

The financial account saw foreign investors reallocating investments and drawing down more than 50 billion rupees from government securities in recent months, mostly due to the interest rate environment.

“We have not been able to go out to the market and refinance some of the loans we took post war, so a lot of them are bunched up this year as well as next year,” he said referring to government borrowings.

With the possibility of a rate hike in United States, for the first time in a decade, and China having reduced its interest rate and depreciated its currency, Sri Lanka must carefully weigh its options. Interest rates rose 30 basis points this week, with the central bank indicating it was comfortable with this managed adjustment.

“We have seen about two percent depreciation of the currency for the year so far. But when you look at some of the competitor currencies it is not as much. This is against the backdrop of a strengthening dollar,” Fernando said.

Former Deputy Minister of Policy Planning Harsha de Silva said recently that an adjustment of currency and exchange rates may not change fundamental competitiveness.

But Frontier Research believes a currency depreciation is needed to offset pressures building up in the balance of payments.

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Navin Karunatilaka
Navin Karunatilaka
7 years ago

How can consumption by individuals lead to a balance of payment crisis. Budget deficits lead to BoP crisis.
When there is a budget deficit governments have to borrow internally and externally. This leads to pressure on currency. The Central Bank tries to support the currency by selling dollars (this is what is happening) and this leads to a BoP crisis. It is silly to say consumption by private individuals can lead to a BoP crisis in a country.

Shee Lankan
Shee Lankan
7 years ago

I think he means, trade deficit increasing due to imported goods consumption leading to BoP crisis !

Navin Karunatilaka
Navin Karunatilaka
7 years ago
Reply to  Shee Lankan

Trade deficits doesn’t create BoP crisis. Trade deficits are neither good nor bad and is a consequence of central bank monetary policy. In this case it’s only a symptom. BoPs are created due to budget deficits. This is how our savings are wiped out and is the road to dependency On the state.

dinesh
dinesh
7 years ago

There are both traditional and more novel causes of balance-ofpayments
crises. A traditional cause of balance-of-payments crises is
a sudden and severe increase in a country’s trade deficit.’ Such an
increase might occur, for example, if bad weather drastically reduces
production of key export crops and export earnings. Another classic
case is one in which a steep rise in oil prices dramatically increases a
country’s import bill. An “oil shock” of this kind occurred in 1990
and 1991 as a result of the Gulf War. The Gulf War oil shock was
instrumental in the balance-of-payments crisis experienced by India
in 1990 and 1991. Whether the suddenly increased trade deficit is
due to lower export earnings or a higher import bill, it creates the
same effect: a sharp drop in demand for domestic currency relative to
foreign currency.
In recent years, the capital account side has become an increasingly
frequent source of balance-of-payments difficulties for developing
countries. A sudden and sharp reduction of foreign investment-
typically short-term portfolio investment-in domestic assets
can also produce a sharp drop in demand for domestic currency relative
to foreign currency, creating the same effect as a rapid rise in the
trade deficit.
Capital and current accounts can work in tandem to create balance-
of-payment difficulties, particularly under a rigid exchange rate
regime. In Thailand during the 1990s, for example, large capital inflows
created a booming investment sector. This investment sector
increased demand for imports, particularly capital goods. At the
same time, a government policy of maintaining a strong currency
made exports less competitive and created trade deficits in the mid-
1990s. 14 Finally, increasingly acute concerns about the domestic
banking system caused investors in 1997 to exchange their Thai assets
for non-Thai assets en masse.”5 The difficulties faced by an overleveraged
banking system created an investor exodus from Thai
capital markets. While capital flows rushed out and the current account
was in deficit, the government attempted to defend the baht,
which was “essentially pegged to the dollar.”” In short, a severe balance-
of-payments crisis struck.
Balance-of-payments difficulties are especially vexing because
they often involve mutually conflicting dynamics – that is, they often
create “catch-22” situations. 17 The traditional balance-of-payments
“catch-22” is the threat of the “downward spiral.” Developingcountry
governments must maintain a fixed exchange rate in order to
preserve the purchasing power of their citizenry and to prevent “consumption
crises” in which sharply depreciated currency prevents
people from purchasing basic necessities. Preserving such an exchange
rate to prevent consumption crises, however, virtually guarantees
crises of another sort-those that arise from recurrent demands
on governments to maintain the currency value

>
T, Chantal (2000). Balance-of-Payments Crises in the Developing
World: Balancing Trade, Finance and Development in the New Economic Order

Link:
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Tilak
Tilak
7 years ago

As per the above the consumption pattern + global issue may be the main cause BOP pressure in SL.How ever in general there could be many others reasons too that can cause BP issues. ie Wrong policies and long rooted curruption are two such factors.Ie For the question why Malaysian Ringgit is 17 year low many international analysts reckon the latter reasons + gloobal issues as the main causes.

Chan Wee
Chan Wee
7 years ago

we are being ruined by the car mafia. the stupid powers kept on giving away permits to all and sundry, which were being sold in the market at hefty profits. do we have the roads for all these cars? why do we keep on importing used cars (usually returned by the japs)? why do we keep on importing high powered cars? what is the point of having a porsche or audi or range rover or lambo when the maximum speed in this country is 72kmph??? these huge engines drink petrol which we dont produce ; then we import it in huge numbers and inflation with it. even in the middle east u need to be highly connected and have to pay extra to get super cars, not becoz they dont have money or petrol but becoz there are no roads / or more precisely the max speed is 140kmph. most sensible economies are turning down high powered cars for performance cars, starting with Japan, Korea, China. even in america is looking at alternative cars like tesla. we must be the only country that discourages brand new cars and hybrid/electric cars for the sake of used petrol bowsers. RUBBISH POLICIES>