Global economic developments and Sri Lanka

Sri Lanka’s trade deficit reached an all-time high in 2011. This is partially due to stagnating exports, but primarily because of the high cost of oil imports resulting from geopolitical uncertainty in the Middle East.

This is symptomatic of a wider issue that concerns the economic stability of the country. The State of the Economy 2012 Report, the Institute of Policy Studies’ annual flagship publication, discusses how strengthening ties with Asia will help bridge this gap. The following is an abstract from the report.

After suffering a major setback in 2011, the prospects for the world economy strengthening in 2012 remain bleak. With the Euro Zone still struggling to overcome its sovereign debt crisis and the pace of growth in the US constrained by indebted consumers, high unemployment, and a weak housing market, the much needed impetus required to keep the global economy afloat is expected to come from emerging and developing economies. 

However, China has experienced a significant slowdown in 2012 and is no longer the dynamic economic giant it once was. Nonetheless, economic growth in emerging and developing economies is expected to average at 5.7 per cent in 2012, with Asia and Latin America leading the way.

The Sri Lankan economy

The Sri Lankan economy has not been immune to global developments. Economic stagnation in both the US and EU in the recent past has been a concern for Sri Lanka, given that over half of its exports are destined to these two economies. With Sri Lanka’s key exports markets suffering yet another setback, coupled with geopolitical tensions in the country’s major oil importing economies, the trade balance has deteriorated significantly, particularly in the latter part of 2011. 

Sri Lanka’s trade deficit, which has been on the rise since 2005, peaked in 2011, recording a dramatic increase in the second half of 2011. The trade deficit which was US$ 5 billion at the end of 2010 almost doubled to US$ 9.7 billion by the end of 2011. While overall exports grew by 22 per cent supported mainly by industrial exports, imports recorded a massive increase of 51 per cent, reflecting a sharp growth in intermediate goods, led primarily by oil imports and investment goods for government infrastructure projects. 

Corrective policy measures adopted by the Central Bank and the government in early 2012 have helped to a certain extent in containing the deficit, with a sizeable deceleration in expenditure on imports of 24.9% being recorded by July 2012.1 However, Sri Lanka’s export earnings have also recorded declines in 2012 – falling by 17.4% in July 2012 compared to last year. This is clearly a worrying trend for Sri Lanka’s external sector. 

Supply risks owing to geopolitical uncertainty in the Middle East and North Africa created upward pressure on oil prices during the year. However, the slowdown in global economic conditions and industrial activity in 2011 led to a relatively lower demand for oil during the year, causing oil prices to remain close to its 2010 level. 

For Sri Lanka, the threat of rising oil prices has a strong bearing on its external trade account. Although export earnings recorded a considerable increase in 2011, this was by no means sufficient to offset the rising import bill. Had Sri Lanka maintained a more diversified export base, both in terms of products and markets, there would have been scope for higher export earnings, thereby lessening the adverse impact on the trade balance. 

FDI flows to Sri Lanka over the period 2005-2011 have been fairly volatile, owing both to domestic and external developments. With net inflows having peaked in 2008 – led by the rapid increase in telephone and telecommunication related FDI – there was a sharp drop following the global downturn. FDI inflows in 2011 increased with the post-conflict recovery in the economy, led by FDI into the hotels and restaurants on the back of expected expansion of the country’s tourism activities. 

Sri Lanka’s sources of FDI have seen a change over the years, with a clear shift from Western economies to developing and emerging Asian countries. Similarly, in terms of foreign finance funding, the relative contribution by multilateral donors such as the World Bank and ADB has declined, while bilateral donors have become more significant. China is the primary source of foreign finance, accounting for 25 per cent of the total in 2010. 

Regional dynamics and Sri Lanka

It is no surprise that Sri Lanka has very little involvement on the global scale, but it is disappointing to note that it also has a minimal amount of involvement in regional dynamics as well. The country only has four regional trade agreements in place – i.e., the bilateral agreements with India and Pakistan, the South Asian Free Trade Agreement (SAFTA), and the Asia Pacific Free Trade Agreement (APTA). 

All together these agreements cover only 21 per cent of its total trade.2 Closer cooperation with India could bring about greater access to other emerging and rapidly developing markets in Asia. As of now, Sri Lanka has very limited integration with East Asia.

In contrast to the highly-concentrated export destinations, Sri Lanka’s sources of FDI, ODA, and foreign finance commitments have shifted over the years from Western markets to emerging economies, in line with global developments. As such, there is a need to diversify Sri Lanka’s export market share and look more strategically at opportunities in the rapidly developing economies of Asia, not only as sources of assistance, but also as economic partners. 

Footnotes

1 CBSL, External Sector Performance – July 2012, Press Release.

2 United Nations Economic and Social Commission for Asia and the Pacific (2010), Asia-Pacific Trade and Investment Report 2011: Post-crisis Trade and Investment Opportunities, United Nations, New York.