BOP crisis: Prospects and uncertainty of non-merchandise earnings

The balance of payments problem the country is facing is unlikely to be solved by an improvement in the merchandise or trade account. The current policies may reduce the trade deficit, not wipe out the trade gap.

The underlying reason for this is the country's structure of imports and exports. This is in turn reflects the structure and weaknesses of the economy: especially the high propensity to import. The expectation is that the trade deficit would be of a manageable proportion so as to be offset by earnings from services and inflows of capital.

The most important item of earnings is worker remittances that are expected to increase and make a significant contribution towards offsetting the trade deficit. Tourist earnings that have been increasing since the war ended nearly three years ago are also expected to make a significant contribution to the balance of payments. The other sources of expected funds are foreign direct investment, portfolio investments, capital infusions into banks and commercial borrowing. It is hoped that these inflows would turn the deficit in the trade account into a balance of payments surplus.

These contributions to the balance of payments have their own uncertainties -- volatility and inbuilt weaknesses. While in several of these, the amount of earnings and inflows are beyond the control of the country, there are significant factors that could determine these earnings and inflows. It is, therefore, important to ensure that economic policies and international developments are managed in a manner that encourages rather than discourages these capital inflows. Security conditions and law and order in the country are also important determinants of these inflows. Worker remittances

Worker remittances have been an important source of funding the balance of payments. In recent years, a high proportion of the trade deficit has been wiped out by remittances from abroad. It is mainly due to this that the persistent trade deficits have not resulted in balance of payments deficits year in year out. In 2010 for instance, 84 percent of the trade deficit of US$ 4.9 billion was offset by worker remittances. However when the trade deficit expanded to as much as US$ 9.7 billion last year, despite the increase in worker remittances by 25 percent over that of the previous year, they were inadequate to offset as much of the trade deficit as before. Remittances were able to offset only 53 per cent of the trade deficit in 2011.

Although worker remittances have increased in recent years there are uncertainties owing to political and economic conditions abroad. A majority of worker remittances come from Middle Eastern countries. In 2010 as much as 60 per cent of remittances were from these countries. The turmoil in these countries has affected the number of workers going to these destinations. The unrest in the region is likely to result in a slow outflow of workers, as well as workers returning from them due to the turmoil in these countries. This is particularly so with respect to workers in Libya, Iran and Syria.

Although a majority of remittances come from the Middle East, other country remittances are significant. There are significant amounts of remittances from North America, Europe, East Asian and South East Asian countries. Remittances from European countries and from the United States accounted for as much as 25 per cent of total remittances in 2010. Even where these countries are concerned the slowing down of their economies and the high rates of their unemployment implies that remittances from Sri Lankans working in these countries as skilled labour or professionals could be adversely affected.

Economic conditions in these countries have a significant impact on the growth of remittances. In the case of remittances from Middle Eastern countries, political conditions would determine the number of workers going to these countries and the amount of such remittances. Perhaps the full impact of the conditions in the Middle East has not been felt yet. Even though the amount of remittances may not decline, the rate of increase of such remittances may slow down.

The expectation of the exchange rate depreciation would have deterred some from remitting money earlier. Now that the currency has depreciated appreciably increased remittances are likely. Considering these positive and negative factors remittances could be expected to grow but perhaps by less than last year.

A remittance dependent balance of payments is a somewhat insecure option in the current international political situation. The risks and uncertainties associated with such dependence must be recognized and the dependence on them reduced. Tourist earnings

The increased flow of tourists to the country has been one of the favourable developments in the last two years. There is a continuing increase in tourists from many destinations. Apart from the increase in the total number of tourists the increased flow of tourists from Asian and East European countries have been a positive development as it diversifies tourist earnings and adds stability to the industry. There have been significant increases in tourists from India, China, Malaysia and other Eastern countries. Tourist arrivals have increased by 21 percent in the first two months of this year compared to that of last year. It is, therefore, likely that in 2012 tourist earnings may reach over US$ 1 billion. This could be useful in offsetting about 10 percent of the trade deficit.

There are risks and uncertainties associated with tourism too.

Global economic conditions are an important factor in the growth of tourism. Fluctuations in economic conditions in the rest of the world would have a significant impact. However this external factor is beyond our control. What is important is to ensure that conditions in the country are conducive to tourism. In fact the tourist industry has seen more setbacks in the past owing to security conditions in the country than global developments. Recent violence that has affected tourists will discourage tourists coming to the country. Already there is a drop in the number of tourists coming from Britain in the first two months of the year. Foreign investment

Foreign direct investment into the country has been somewhat tardy. Except for the investments in real estate by the hospitality trade, other investments, in the manufacturing sector in particular, have been very little. Foreign direct investment is needed not only from a balance of payments perspective, but also from the perspective of long-term economic development.

Significant investments are needed in export industries that would enhance the country's export earnings, provide employment, make use of local raw materials and contribute towards the enhancement of management and technical skills. One of the most important contributions to economic development of FDI would be through the transfer of technology that would enhance the country's economic capacity for development.

The government expects about US$ 2 billion this year from foreign direct investments. Whether this would be achieved depends on an improvement in the investment climate. Meanwhile there has been a substantial increase in portfolio investment with a Malaysian investment firm - about US$ 2 billion -- in company stocks. Portfolio investments are however fleeting short-range and temporary. As much as they may come they may be taken out. Dependence on portfolio investments for balance of payments support is undependable. Foreign borrowing

Foreign commercial loans to solve the balance of payments problem is a palliative that results in further burdens on the balance of payments as these are contingent liabilities. Such borrowing ameliorates the current balance of payments, but increases future burdens on the balance of payments owing to capital repayments and interest costs. Foreign borrowing as a means of relieving the balance of payments must therefore be minimized. Conclusion

The trade deficit has been aggravated by public spending mainly from foreign borrowing, the escalation of oil prices and inadequate export growth. Policy responses too have been inadequate and belated. For these reasons the merchandise account will be in deficit by a large amount this year too.

Earnings from services and capital inflows are expected to resolve the deficit in the merchandise account. There are uncertainties in the extent of these due to both global and domestic conditions. The domestic situation, especially with respect to security conditions, law and order and the business environment require to be improved to ensure adequate capital inflows.