Resolving the structural weaknesses of the balance of payments

Trade deficits have been a recurrent feature of the country’s balance of payments. There have been trade deficits in most years and balance of payments surpluses in some. Reducing the endemic trade deficits are vital to strengthen Sri Lanka’s external finances.

Regular feature

Although trade deficits have been a regular feature of the country’s post-independent economic history, there have been balance of payments surpluses in several years. These have been achieved due to financial inflows, foreign investments, earnings from services and most important workers’ remittances of foreign exchange and earnings from tourism.

Trade balance

There have been trade surpluses in only about four or five years from 1950 onwards and these surpluses have been small. The country’s last trade surplus was in 1977. It was less than US$ 100 million and achieved with stringent import controls and severe hardships to people. Basic necessities like bread, milk and medicines were scarce.

BOP Surpluses

However there have been balance of payments surpluses in several years. These have been achieved due to financial inflows, foreign investments, earnings from services and most important tourism and workers’ remittances of foreign exchange.

In recent years trade deficit were either completely offset by workers’ remittances and earnings from tourism or a large proportion of it was offset. These were the two strengths of the balance of payments.

There have been recent years when despite large trade deficits, the BOP was either in surplus or had a small deficit due to these strengths in the external account.

For instance in 2017, in spite of a large trade deficit of US$ 9.6 billion, there was a BOP surplus of US$ 2.07 billion owing to mainly workers’ remittances and earnings from tourism of about US$ 11 billion.

In other years, despite large trade deficits, the BOP deficit has been reduced significantly. For instance, despite a large trade deficit of US$ 10.3 billion in 2018, the BOP deficit was only US$ 1.1 billion owing to workers’ remittances and earnings from tourism of about US$ 11.4 billion.

In contrast, although last year’s (2019) trade deficit was reduced to US$ eight billion, yet there was a BOP surplus of only US$ 0.4 billion due to the decreased earnings from tourism owing to the Easter Sunday terrorist attacks on churches and hotels. Yet, the deficit in the trade balance was offset mainly or owing to workers’ remittances of US$ 6.7 billion.

BOP strengths

It is therefore clear that workers’ remittances and tourist earnings have been the main strengths of the balance of payments in recent years. They have reduced or offset the persistent trade deficits. Imports being nearly twice the value of exports have been the core weakness of the BOP.

This year

The story this year is somewhat different. Although the trade deficit is likely to be contained to a modest amount due to decreased imports, the balance of payments deficit is likely to be high due to the two recent strengths of the BOP weakening.

Tourist earnings have fallen sharply and workers’ remittances have dipped significantly. Consequently, the BOP will be in deficit and there would be an erosion of the country’s foreign reserves.

Trade deficit 2020

This year’s trade deficit is likely to be less than last year’s despite a fall in exports owing to a restriction of imports and a saving on oil imports due to decreased international prices. This is indicated in the trade performance for the first seven months of this year when it was only US$ 3.47 billion.

However, trade and balance of payments deficits are likely this year. Although the trade deficit is likely to be contained to around US$ six to seven billion, reduced workers’ remittances and the sharp decrease in earnings from tourism will not offset the trade deficit by much this year.

The BOP deficit was US$ 937 million in the first seven months. Workers’ remittances and earnings from tourism amounted to only US$ 4.5 billion during this period. Net capital outflows are also likely to weaken the balance of payments. Consequently, it is likely that there would be a balance of payments deficit of about US$ 1.5 to two billion this year.

Expectations

If the increased exports since June accelerate to over US$ one billion in the last five months, it could make a useful contribution to the narrowing of this year’s trade deficit. On the other hand, the relaxation of controls on certain non- essential imports like gold and increased raw material imports could widen the trade deficit.

Balance of payments

Despite the reduction of the trade deficit, the balance of payments has deteriorated in the first seven months of the year from a surplus of US$ 1.4 billion to a deficit of US$ 0.94 billion this year mainly due to the decrease in workers’ remittances and tourist earnings from nearly US$ six billion to only from US$ 4.5 billion.

Summing up

This year’s balance of payments has deteriorated in spite of a narrowing of the trade deficit in the first seven months of this year. The trade balance has to be strengthened by increasing exports.

Way forward

Attempting to achieve a better trade balance by restricting imports is a short sighted approach. A high proportion of imports are essential consumer, intermediate and capital goods. These include, wheat, sugar, fertiliser, fuel, chemicals, textiles for apparel exports, raw materials for manufactures and machinery.

Import substitution is desirable, but only a limited amount of import substitution is possible and economically desirable. The long term solution is to expand exports.This implies increased exports of not only manufactured goods but agricultural exports.

Increasing the exportable surplus of tea and spices are important. Increased production of rubber would contribute towards the expansion of rubber manufactures. Increased coconut production could reduce imports of edible oils. What is needed is a long term strategy to enhance exports and reduce imports.