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.
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.