Of trade and budget deficits
Sri Lanka’s persistent trade deficit – the gap between export income and import expenditure - has finally declined, according to official data. It was nearly US$8 billion last year 2019, compared to US$10 billion deficit in 2018. But I am not sure, if this is good news to be happy rather than worry.
Sri Lanka has been experiencing a persistent trade deficit so anyway its reduction is good news. However, the reduction in the trade deficit is a result of a significant decline in import expenditure more than an increase in export income, which is a worrying development.
Today, I thought of discussing this point so that we will be able to understand the gravity of the issue of trade deficits and its decline as well as the future directions of the economy.
Decline in trade deficit
Export income in 2019 has been reported at $ 11,940 million. Compared with the previous year, this is an increase by 0.4 per cent only. Import expenditure has been $ 19,937 million, which is reported to be a decline by over 10 per cent. The result has been a reduction in the trade deficit.
On the export side, while textile and garments have increased by over 5 per cent, most of the other exports have declined. On the import side, consumer goods declined by 20 per cent, while its non- food consumer goods declined by 25 per cent. The reduction in personal vehicle imports accounts for the major import item in the non-food consumer goods. In addition, both intermediate and investment goods have declined too respectively by 9 per cent and 2 per cent. In the intermediate category, fuel accounts for a major share of import expenditure which has declined by over 6 per cent.
Even though there has been a reduction in the world market prices and changes in import duties of the country, the export- import trends do not appear to show an admirable healthy sign of the economy. Although we don’t have to undertake a sophisticated analysis to examine these issues, the performance of both exports and imports do not appear to be healthy, but consistent with the dismal economic growth outcome as well.
In principle, economic growth cannot rise without export growth. Even if it does due to “domestic” economic activities, growth without exports cannot be sustained for long. Thus, slower growth under 3 per cent is, actually consistent with sluggish export performance.
With economic growth, imports too should rise. It is not surprising to hear the opposite too. Some may think that when we cut down imports, “domestic” industries do well so that economic growth should rise. Whether they are domestic or international, industries need a ‘market’ so curtailing the market with import controls or otherwise does not generate economic growth.
Economic growth and import growth go hand in hand for two reasons: Firstly, economic growth generates jobs and incomes so that people demand consumer goods. Thus, import expenditure on consumer goods should rise. Secondly, economic growth requires intermediate goods – raw materials, parts and components, and semi- finished goods. And economic growth also requires capital goods – transport goods, tools and equipment, and machines.
As economic growth and imports move closely in the same direction, generally a fall in import expenditure is consistent with sluggish economic growth performance. Therefore, neither the sluggish export growth nor the decline in imports is a sign of a healthy economy with sustained economic growth.
Exports for development and stability
With almost stagnant export income now, probably the economy has come to a critical juncture. Export growth is important for both development and macroeconomic perspectives, while its slowdown over the years has raised fundamental issues regarding both aspects.
Export growth is important from a development perspective, because it provides an opportunity to raise incomes and create jobs for the people as well as means of reducing poverty. All these developmental achievements are based on industry expansion which is not constrained by the size of the market. Exposure to the international market also challenges the industries to remain competitive. The international market provides not only the opportunities to exploit, but also the challenges to overcome.
A slowdown in export growth means that the country is getting isolated from the international market, challenging all developmental achievements – income growth, job creation, and poverty reduction.
Export growth is needed to maintain a healthy external finance position and the exchange rate flexibility and stability. It is true that there are other means of foreign exchange inflows, but if we want the exchange rate to reflect the country’s productive capacity and international competitiveness, it is based on export growth much more than anything else.
In the absence of adequate export growth, the exchange rate becomes increasingly exposed to the volatile foreign exchange inflows to the country’s bond market and stock market. As a result, the country will have a weak exchange rate with high degree of volatility. An exchange rate as such, will disrupt the Central Bank’s attempt to achieve its monetary policy objectives as well.
Export growth is needed for meeting the foreign debt obligations. Nearly $ 5 billion foreign debt repayment this year requires foreign exchange that should have ideally come from export growth. In the absence of export growth, request for a debt moratorium as well as further borrowings from abroad are inevitable.
Transit lounge
All indications show that the economy is at a crossroad, which is critical for the years to come. I too often come across usual questions such as “what do you think about the economy?” and “where are we moving now?”
I always respond: “Be patient, we are in a transit lounge; somewhere by the middle of the year, we would clearly see where we are moving”.
It is a fact that, however, the economy would not take off without export growth; and that export growth would not come without private investment; and that private investment would not come without a conducive business environment; and f i n a l ly, that a business environment as such would not appear without reforms, even though ‘ reforms’ is already a discarded term.
By the way, we can raise economic performance even without export growth. But we have enough evidence to believe that economic performance as such would not last long. Increased government spending, which raises ‘aggregate demand’, is a major impetus that sustains such temporary economic performance.
There is a problem, however. Increased government spending requires a corresponding increase in tax revenue for the government, which may not exist without adequate private i nvestment. This means increased government spending leads to budget deficits and further borrowings – a strategy that we have followed for many years now and, confirmed and re- confirmed that it wouldn’t work.
Many countries in Asia including Sri Lanka have confirmed that growth supported by increased government spending have ended up with the so-called “twin deficit” problem – budget deficit and trade deficit. At the same time, some other countries in Asia, which have focussed more on export growth than anything else have not plunged into the twin deficit problem.
Their economic performance was fuelled by exports, leading to trade surpluses. And, as a result, they have also been able to manage their government spending leading to a healthy budgetary outcome.
The World Bank’s South Asia Economic Focus – Spring Issue 2019, titled “Exports Wanted” has identified the issue as a South Asian commonality. Although South Asia has been the fastest-growing region in the world, as the report highlights, “… growth remained driven by domestic demand – and not exports…” And Sri Lanka has already demonstrated what comes at the end of the story a slowdown in growth with a twin deficit.
( The writer is a Professor of Economics at the University of Colombo and can be reached at sirimal@econ.cmb.ac.lk).
By the way, we can raise economic performance even without export growth. But we have enough evidence to believe that economic performance as such would not last long. Increased government spending, which raises ‘aggregate demand’, is a major impetus that sustains such temporary economic performance.