Fundamental structural weaknesses in trade

The persistent trade deficits experienced since 1950 is due to structural weaknesses in the country's trade composition. These structural weaknesses resulted in massive trade deficits of more than US$ 9 billion in the last two years.

Containing the trade deficit to more manageable proportions of about US$ 6 to 7 billion is difficult owing to the import-export structure. Only a long term strategy to change the country's external trade structure could ensure lesser vulnerability in trading fortunes.

Export earnings have been much lower than import expenditure in almost every year since 1950. Import expenditure was about twice export earnings in 2011 and 2012. There are serious constraints to decreasing imports as a high proportion of imports are difficult to reduce owing to their essentiality or what economists call inelasticity.

Export earnings too have been difficult to increase due to dependence on a few key exports (tea and textiles) whose demand is inelastic and highly dependent on the economic performance of the US and European countries and political factors detrimental to the country's key exports and imports.

Problem in perspective

The trade imbalance is not a new problem. Structural deficiencies in the trade structure have been responsible for the continuous trade deficits over six decades. The balance of trade has been persistently in deficit since 1957. The only year after 1957 when there was a surplus was in 1977 when the trade surplus was a mere US$ 41 million (about Rs. 200 million at that time). Even this small surplus was achieved by severe import and exchange controls.

The structure of imports and exports has resulted in the terms of trade being adverse for many years, especially till the 1980s. The long-term adverse terms of trade caused by the relative fall in the prices of tea, rubber, and coconutthe main exports at that time-- was an important cause for trade deficits till the 1980s. Furthermore, import prices increased and the demand for imports expanded because of increased demand for imports owing to population growth and growing demand for a variety of consumer goods generated by higher incomes and expectations.

Adverse terms of trade

Few countries experienced as drastic and long-term deterioration in the terms of trade as Sri Lanka from the mid-1950s to the mid-1970s. For instance, in 1975, although the volume of exports was 18 percent more than in 1960, these export earnings had a purchasing power of only 37 percent of the smaller volume of exports in 1960. The impact of the terms of trade on the country's external trade could have hardly been any worse.

There were occasional exceptions when the terms of trade were favourable. The terms of trade improved by 35 percent in 1976 over 1975, and by 31 percent in 1977 over 1976, when tea prices experienced an unprecedented rise of 80 percent. From 1979 to 1982, however, the terms of trade again turned sharply against Sri Lanka, reaching record lows in 1981 and 1982. Between 1983 and 1987, the terms of trade hovered near the level for 1981, with the exception of 1984, when an increase in the price of tea produced a temporarily more favourable position. In recent years too the terms of trade have been unfavourable except in 2008 and 2010. The prices of tea and petroleum are the main determinants of the terms of trade. The depreciation of the currency too deteriorated the terms of trade in 2012.

Import controls

For most of the 1960s and 1970s, the Government imposed strict import and exchange controls to contain imports and reduce trade deficits. As a result, the volume of imports fell, at first through severe restriction of basic food items, luxury items, such as automobiles, consumer durables and alcohol. However the structure of the economy limited the amount by which imports could be cut as food, medicines, spare parts, and fertilizer could not easily be reduced without damaging the economy or the population's welfare. These restrictions created shortages that resulted in the failure of the import substitution industrial development strategy.

Post-liberalisation in 1977

The trade deficit widened considerably after the liberalisation of the economy in 1977, as the import bill soared due to freer imports and the Government's development programme. Exports, however, remained largely static. The trade deficits were financed by increased foreign support and heavy borrowing. The IMF supported the liberalisation of imports and assisted in a structural transformation of the econo- my

he trade deficit expanded year by year and reached nearly US$ 1 billion in 1982, equal to 22.4 percent of GDP. In 1983, as a result of good agricultural production, the deficit was held to the same level as in 1982 and reduced in 1984, to less than US$ 500 million as a result of exceptionally high tea prices. This gain was not sustained in 1985, when the trade deficit rose to US$ 729 million. In 1986, despite a static level of imports attributable primarily to the decline of world oil prices, the trade deficit again widened, to around US$ 764 million.

Trade deficits continued to increase to between US$ 1-3 billion in the 1990s and in the first decade of the new millennium. The price of petroleum and tea prices were the factors responsible for the terms of trade in recent years. Trade deficits increased sharply in 2011 and 2012 due to import expenditure rising, while exports were sluggish.

Import export structure

Although the import-export structure of the country changed since the 1980s from a predominantly agricultural one to one of higher manufactured exports, trade vulnerability remains. The economic transformation since the 1980s has resulted in a high dependence on intermediate imports as well as capital imports. Consequently international prices of intermediate imports such as oil, fertiliser and other raw material are of considerable significance to the trade balance.

An analysis of last year's trade structure demonstrates the fundamental weakness of the country's external trade profile. In 2012 imports were nearly double the export earnings. Intermediate imports that constituted 61 percent of total imports were over twice (118 percent) export earnings. Investment goods imports that constituted 23.5 percent of import expenditure absorbed 50 percent of the country's export earnings. Fuel imports that were 26.4 percent of import expenditure were twice (216 percent) the value of tea export earnings. Textile imports absorbed two thirds of garment export earnings.

The country is highly dependent on tea and garments exports. Tea exports were nearly 40 percent of export earnings and 60.5 percent of agricultural exports. All other agricultural exports accounted for less than 40 percent of agricultural exports. Garments exports accounted for 55 percent and rubber manufactures for another 11.6 percent of industrial exports. Other industrial exports constituted only a third (33 percent) of manufactured exports. These figures demonstrate the need to diversify both agricultural and industrial exports to ensure resilience in the trade balance.

Investment goods imports increased by 60 per cent in 2011 over that of 2010 and by a further 4.8 percent in 2012. Investment goods import expenditure in recent years is rather disproportionate in relation to the country's import capacity. As much as US$ 4.5 billion or 23.5 per cent of import expenditure is on investment goods that absorb one half of the country's export earnings. In the current context of the large trade imbalance, there should be a reduction of capital expenditure that has high import content and does not increase exports or has a long gestation period.

Challenging task

These structural features of the country's trade make it exceedingly difficult to reduce the trade deficit. On the import side, consumer goods imports have been reduced to an extent that further possibilities of reducing consumer imports are very limited. Intermediate imports that consist mainly of fuel, textile and other raw material for industry, cannot be reduced by much, though higher prices for fuel may reduce petroleum imports. Reduction in investment goods are a possibility that should be explored.

It is a long run strategy to change the fundamental structural deficiencies of the trade pattern by diversifying both agricultural and industrial exports to generate adequate exportable surpluses and reduce imports and increased earnings from services that could strengthen the trade balance.