Sri Lanka trade deficit obsession misplaced: focus

May 18, 2013(LBO) – Sri Lanka’s obsession with trade deficits is misplaced because it ignores the broader exchanges including services that take place between citizens of one county and another, economists and officials have said.

Saman Kelegama, head of the Institute of Policy Studies, a think tank, said the obsession was particularly strong in relation to free trade agreements.


“Always when a free trade agreement is signed with a large country there is the thinking that the sole objective of the free trade agreement should be to reduce the trade deficit between the large country and the small country,” Kelegama told a business forum in Colombo.

“Actually the objective of the agreement should not be mainly to reduce the deficit. Rather to give the best deal to the consumer, to get better access to the exporters of the smaller country, and also to give reasonable protection to the efficient import substitution industry.”

The so-called ‘negative list’ of the Indo Lanka Free Trade Agreement where Indian producers were able to block poorer Indians from buying Sri Lankan products was only 431 items.

But Sri Lankan producers were able to block poorer consumers from buying 1,220 Indian products, through high tariffs reflecting the political clout of domestic business, and their ability to overcharge consumers in the island.

Since the signing of the free trade agreement India has become Sri Lanka’s third largest destination for exports. In 1999 India and Sri Lanka were trading 505 different items. In 2005 it had doubled to 1,062. It had again doubled to 2,100 by 2011.

About 70 percent of Sri Lanka’s exports to India now went under the agreement, while only 30 percent came to Sri Lanka from India under deal.

Big Picture

Kelegama said Sri Lanka had a trade surplus with some countries, such as the US and the European Union and Middle East.

“But with the main import sources of Sri Lanka like India, China and the Middle East we have a deficit,” he said.

“So in the globalized world when you are a trading with the outside world you are bound to have surpluses with certain countries and you are bound to have deficits with certain other countries.”

The overall external exchanges between the two countries or any other country go beyond merchandise trade (goods).

When state-run SriLankan Airlines was under Emirates management it was the top foreign carrier to India operating in excess of 100 flights a week.

But last year Emirates became the top airline with 185 flights a week, carrying 4.5 million passengers, more than state-run Air India.

The Middle East from where Sri Lanka imports oil (India has also now become a source of oil) is also a key source of remittance which come not from exports of goods, but exports of services – labour.

India is Sri Lanka’s largest source of tourists a key services component in Sri Lanka’s economy. Colombo port is completely dependent on Indian transshipment containers.

India’s envoy to Sri Lanka, Ashok K Kantha said Colombo port accounted for one fourth of India’s container transshipment cargo. And 70 percent of the ports business came from India.

India has also given a credit line to Sri Lanka to rebuild railways, which will increase the trade gap as material is brought from the country to build track.

Indian companies are also investing in Sri Lanka.

When borrowings are spent to build roads or power plants, or factories are built with foreign director investment with imported machinery and materials, the ‘trade deficit’ expands.

Services Exports

Trade deficits, which are only a part of the overall balance of payments are essentially a function of savings propensities of people in a given time period. State and private borrowings and foreign direct investments are key drivers of the trade deficit.

Sri Lanka’s central bank is also trying to educate the country to move beyond trade deficit myopia and show the broad range of external activities especially services trade that is taking place.

Its monthly trade data, which used to contain only merchandise exports and remittances now have tourism receipt and borrowings.

“In the next few years our economy will have a gradual shift from traditional areas such as trade only to new areas as well, particularly services,” Central Bank Governor Nivard Cabraal said in April after releasing the bank’s annual report on the economy.

“You would have noticed that our statements for the external sector are now worded slightly differently, because traditionally, it was only a statement which carried trade data. But today we are digressing from that and showing the evolution of our economy.”


The obsession with trade deficits is part of a branch of economics known as Mecantilism, which dates back to the days of slave trading and beyond.

It was the dominant economic thinking in Europe and was a widely used to analyse activities before classical liberalism, and capitalism became widespread in Europe.

Large corporations such as the British East India Company, which operated with the backing of the Sovereign through a Royal Charter were exponents of Mercantilism.

“Although a Kingdom may be enriched by gifts received, or by purchase taken from some other Nations, yet these are things uncertain and of small consideration when they happen,” wrote Thomas Munn a director of British East India Company (England’s Treasure By Forraign Trade, 1664 ).

“The ordinary means therefore to increase our wealth and treasure is by Forraign Trade, wherein wee must ever observe this rule; to sell more to strangers yearly than wee consume of theirs in value.”

In Sri Lanka trade deficits became a problem to some after the creation of a money printing central bank, which generated currency depreciation after a fixed exchange rate (Currency Board), was abolished in 1951.

Exchange rates and currency depreciation have little to do with trade deficits, but is a function of money and credit.

Free traders say the actual benefit of foreign trade is to the poorest consumer in a country who spends their hard earned money – such as that earned in the Middle East – on the most cost effective good he wants to.


Free trade gives them liberty especially to the poor who are not rich enough to beat tarriffs from protected production lobbies run by neo-Mercantilists with rigged customs regimes maintained through the police power of the Sovereign state than by Royal Charter.

People buy Indian or Chinese goods not because they are ‘powerful’ in anyway but because they please the consumer – especially the poorer ones – with cheaper prices, higher quality or both.

Successful capitalist mass-market producers are essentially helpless slaves of the free market, which is a collection of individual customers who exercise their liberties.

But consumers do not have an effective voice or political clout in many countries, unlike production lobbies.

“One voice that is hardly ever raised is the consumer’s. That voice is drowned out in the cacophony of the “interested sophistry of merchants and manufacturers” and their employees,” wrote Milton Friedman, a US economist.

“Another fallacy seldom contradicted is that exports are good, imports bad. The truth is very different. We cannot eat, wear, or enjoy the goods we send abroad,” he wrote.

“Our gain from foreign trade is what we import. Exports are the price we pay to get imports.

“As Adam Smith saw so clearly, the citizens of a nation benefit from getting as large a volume of imports as possible in return for its exports or, equivalently, from exporting as little as possible to pay for its imports.

“The misleading terminology we use reflects these erroneous ideas. “Protection” really means exploiting the consumer. A “favorable balance of trade” really means exporting more than we import, sending abroad goods of greater total value than the goods we get from abroad.

“In your private household, you would surely prefer to pay less for more rather than the other way around, yet that would be termed an ‘unfavorable balance of payments’ in foreign trade.”

Update II