Dwindling foreign exchange reserves of Sri Lanka:

Dwindling foreign exchange reserves

By the Economist
The Central Bank is certain that the foreign exchange reserves of the country at the end of 2008 are quite adequate. The gross official reserves of US$ 1,753 million by end December 2008 it states are equivalent to 1.5 months of imports on the basis of the previous 12 month average imports. The Bank also makes the point that the “total reserves, with and without ACU funds, by end 2008 were US $ 3,799 million and US $ 2,992 million respectively and these reserve levels are equivalent to 3.3 and 2.6 months of imports, respectively.” These several figures, especially the counting of reserves in the Asian Clearing Union as part of the country’s reserves, have contributed to some confusion. However that is not the issue that we would address here. We discuss here some of the basic issues in the external finances of the country and the emerging situation. The fact is that the external reserves have come down and there is a public apprehension that they are at a critically low level.

The Central Bank points out that the adequacy of the reserves for imports has been based on the high import bill of last year and that current and expected low imports, resulting from the sharp reduction in the oil and petroleum product import bills, would ensure that the actual number of months of imports is much higher than those quoted above. This is most likely as the downturn in import prices of oil in particular will ease the trade balance. The monthly requirements of imports are likely to be less than those of 2008. There are however other aspects that have to be considered too. This is in respect to the prospects for the country’s exports that we discuss later in this column.

Irrespective of the adequacy of the reserves for imports, the serious concern is that the foreign exchange reserves have been dwindling last year. This is clear when one compares the reserves at the end of the two previous years. In 2006 foreign exchange reserves (total official assets) were US $ 4005 million. At the end of 2007 it had risen to US$ 4956 million. The foreign exchange reserves at the end of 2008 were much lower at 2992 million US $. Therefore it is clear that the external reserves had dwindled significantly and were much lower than what it was at the end of the previous year. This is an incontrovertible fact. Moreover even when the foreign exchange reserves rose in 2007, it was due to heavy borrowing by the government. In fact the decrease in the foreign reserves in 2008 was partly owing to the repayment of loans taken previously.

The Central Bank’s expectation that import expenditure would be less this year is quite reasonable as import prices of petroleum and other essential imports have been low this year. If they remain at a low level, which is likely, there is no reason to think that the recessionary conditions would be reversed in the next ten months. Then the import bill would be significantly lower. Even more certain is the fact that even if oil prices rise they will not reach the heights of last year. In 2008 the country spent US $ 3368 million on oil imports alone. This was almost one fourth (24 percent) of the total import expenditure of US $ 14,008 million.

It may be realistic to expect the expenditure on oil to be about 30 percent less. Such an expectation is based not only on the price of oil remaining at current levels but that domestic consumption will not rise. Further reduction in the domestic fuel price could change this expectation. This is an important argument for keeping the price of petroleum products high through taxation. Similarly the prices of other imports are expected to remain around current levels. Lesser economic activity, especially in respect to manufactures, would also ease intermediate imports. If this were to happen then the import bill of the country would be significantly less.

There is however another part of the trade equation that must be considered. While import expenditure is likely to decline, export revenues too could drop significantly. This has happened in recent months. For instance, last December exports declined by 19.1 per cent compared to December 2007. The performance of agricultural and industrial exports, have been adversely affected by the downturn in commodity prices. Tea exports earnings decreased by 22.5 per cent in December mainly due to price reductions in the international market. Similarly rubber prices are on the decline. Therefore in considering the trade balance for this year the prospects of export expenditure decreasing must be counter balanced by the prospect of lower agricultural and industrial export earnings. On balance, the recessionary conditions are likely to benefit the trade balance more than being unfavourable to it. However any optimistic expectations in improvements in import expenditure must be tempered with the prospect of lower export earnings. The trade deficit may be less than in 2008, but it would nevertheless be a deficit and not a small deficit either.

The persistent trade deficits have not generally resulted in balance of payments deficits owing to capital inflows. Despite the unfavourable developments in trade the country has had small surpluses in the balance of payments. In 2007 the balance of payments surplus was US$ 531 million. In 2008 too the expectation is a balance of payments surplus of about US$ 400 million. In recent years this surplus in the balance of payment has been achieved owing to private remittances from abroad and large scale foreign borrowings. Private remittances have counterbalanced a significant proportion of the trade deficit. For instance in 2008 private remittances financed around one half of the trade deficit. In 2008 apart from the massive trade deficit there was an outflow of funds to repay a part of the foreign loans borrowed in earlier years. This also accounts for the dwindling of the foreign reserves of the country.

No doubt the government has plans to replenish the reserves through further borrowing. It is very important that such borrowing is on terms that are not too onerous. It is vital that the problem faced by the country at the present moment is not transformed into a burden for the future. The foreign debt of the country has reached a high proportion already and every effort must be made to ensure that debt servicing costs are not excessively onerous.
State finances on life-support

Politics Unwound by Rakshaka - Lakbima:

This is the week in which Fitch Ratings, the international financial outlook index brought down Sri Lanka’s rating from a ‘stable outlook’ to a ‘negative outlook’ underscoring the financial morass the state may be getting into, even as the war is near an end and the LTTE is on life-support.
Harsha de Silva, economist, had earlier in the week told TIME magazine that ‘’it just doesn’t work’’ to fight a war at such an expense because the government is in clear financial trouble due to the double impact of the global meltdown and the war-budget.
But, the people are definitely with the government, especially in this last mile when after decades and more for the first time there seems to be virtual certainty that the LTTE, as we know it, as an organized fighting force can now be eliminated.

Problems later

The provincial council polls which were deliberately made a referendum on the war, also clearly indicated that there is clear support for the government on its strategy to wipe out the LTTE and think about financial problems later.
However, the problems were getting messier, with a great many people being directly affected by the first sign of trouble in any melting-down economy —- the unraveling of ponzi schemes in which finance companies had offered unrealistic interest rates to investors.
When Lalith Kotelawala, the virtual financial czar of the country was remanded last week — it seemed that there was no more chance of keeping a lid on these nasty developments in the financial sector.
President told Cabinet that he is introducing a ‘stimulus package’ to help finance companies pay investors and tide over their immense difficulties, and Central Bank governor Ajith Nivard Cabraal was on hand to explain the package.
He said that monies lent by the government to finance companies would eventually be recovered by Lankaputra Bank, and that lending would be on collateral provided by the finance companies.
Ministers however were skeptical, saying there is little likelihood that monies could be recovered whereupon a senior minister had to intervene to say that this is what’s called a ‘stimulus package’, meaning it was also in effect ‘free money’’ to keep hapless investors from losing. The president intoned somberly that ‘the people should be protected from the deteriorating global situation.”
More ‘meltdowns’’ and other disasters could be in store for the people in the financial sector if the Fitch ratings etc., are anything to go by, even as gas prices came down drastically however, due to sliding gas and oil markets worldwide.

Embroiled

It’s in this atmosphere that the government and opposition parties handed in their nominations for the Western provincial council elections last week.
The UNP was embroiled in its usual post election leadership problem when the party’s parliamentary group met at Sri Kotha. Rukman Senanayake, Johnston Fernando, Lakshman Seneviratne, Jayalath Jayewardene etc., lambasted the leader and said his time is definitely up, but others such as Vajira Abeywardene, Renuka Herath etc., as usual said that this is not time to oust the leader when the UNP is fielding ‘a better list than the UPFA in the Western province and could win there.’
On the government’s side, the UPFA nominated Raginold Cooray the former chief minister at the head of the list in Kalutara, which could be seen as a demotion, and Sunil Jayamini at the top of the list in Colombo, which seemed to indicate that a relative newcomer at the top of the list would give the advantage to anyone who might top the preferences in Colombo.
Thilanga Sumathipala, probably the most publicly known face in the UPFA list started his publicity campaign last week soon after nominations were handed in a campaign office at his home in Punchiborella.