President Gotabaya Rajapaksa’s speech to the nation on March 16 was notable for announcing that he expected to seek assistance from the International Monetary Fund (IMF). He also explained how the external finances will improve this year.
Although interest in this speech has waned due to rapidly changing political events and economic changes, it provides a starting point for thinking about one’s economic expectations. How realistic are his economic expectations for this year?
Most important was the revelation that the government was reaching out to the International Monetary Fund (IMF). The president said the government is considering asking for help from the IMF and explained how the country will resolve the balance of payments and currency crisis this year.
Shortly after major economic policy changes the previous week, he announced the government’s intention or serious intention to seek advice and assistance from the IMF to resolve the country’s economic crisis.
The President said that following his discussions with the IMF team, whom he met in Colombo, he decided to work with them after considering the pros and cons.
This is not just a categorical statement of intent to seek IMF assistance, it is a reversal of the strong position taken by the Governor of the Central Bank that we would not seek IMF assistance in because of the conditions (conditionalities in IMF terminology) they set . Instead, the Central Bank Governor had boasted of having a local solution and expertise to handle the external financial crisis.
These local and alternative economic policies like the New Monetary Theory (NMT) have actually worsened the economic difficulties of the country. Moreover, these policies remain unrecognized and ineffective, while the crisis has worsened.
The coming months will unveil the government’s new roadmap in its search for IMF assistance. This was the advice of most economists, think tanks and chambers of commerce for many months. The delay in seeking IMF assistance was costly. To console oneself, one could say better late than never.
Balance of payments
The presidential address was unusual in its discussion of how the government expects a more favorable balance of payments outcome. The speech explained how the balance of payments crisis would be alleviated.
This year’s trade balance deficit is expected to be US$10 billion. That’s more than last year’s trade deficit of $8.1 billion. This is due to an increase in imports due to the increase in international prices of our main imports, as well as an increase in food imports, due to a shortfall in domestic food production.
A slight increase in merchandise exports is expected this year. The government expects merchandise exports to reach $13.6 billion, up from $12.5 billion last year. This is a realistic goal, except for some adverse conditions that develop. The export target may not be met due to several supply constraints.
Exports of manufactured goods which represent about 70% of total exports are currently affected by shortages of raw materials, reduced working hours due to power cuts, unavailability of diesel and difficulties in transporting workers and materials. The export trade expects an export deficit unless these shortcomings are eliminated.
Tea exports, which accounted for $1.3 billion last year, are expected to fall due to a production shortfall of around 20 percent or more due to reduced production due to a shortage of fertilizers and agrochemicals. As a result, tea export earnings could fall by around US$300 million.
In addition, there is also a threat of losing the important Russian and Ukrainian markets due to the war in Europe. When these factors are taken into account, the export earnings target of US$13.6 may not be achievable.
The most urgent need is to increase reserves by increasing inward remittances to around US$5 billion, which is far less than the US$7.1 billion reached in 2020 and even a little less than the 5.5 billion US dollars from last year. In January, remittances were at their lowest in a month and increased somewhat in February. There may be an increase in remittances and capital inflows, if there is confidence that there will be a more liberalized trade and payments regime.
The president’s expectation of foreign aid to overcome the current balance of payments difficulties appears to be materializing. Last week, Finance Minister Basil Rajapaksa signed an agreement to secure a $1,500 million line of credit in addition to a $400 million loan repayment deferral.
On March 22, the Chinese Embassy in Colombo said that China is considering granting Sri Lanka a line of credit equivalent to about 1900 million US dollars.
These two lines of credit may not be in convertible currency and only usable for imports from the two countries. Yet they are a tremendous balance of payments support as they could be used for the import of essential foodstuffs, fuel, pharmaceuticals and raw materials. These imports would relieve the balance of payments by meeting these import expenses and freeing up foreign exchange for other imports.
The two lines of credit, amounting to around US$3 billion, contribute significantly to the country’s foreign exchange shortage.
The expectation of a more favorable trade deficit than last year is unlikely due to difficulties faced by exporters and a drop in tea exports. Imports, on the other hand, are expected to increase due to higher prices of our main imports. The expectation of increased remittances, tourism revenues and other inflows is surrounded by many uncertainties. Remittances and income from tourists are likely to be higher, but not at the amounts projected. There is a prospect of increased revenues from ICT services. It is the Chinese and Indian trade credit lines of about US$3 billion that constitute an important indirect support to the balance of payments.
Taking all the above factors into account, this year’s balance of payments deficit is expected to exceed US$2 billion. However, if international economic conditions reverse and oil and grain prices decline, tourism picks up, and IMF assistance allows for capital account liberalization, then remittances could also hit the bar of 7 to 8 billion dollars. Liberalizing the capital account and floating the rupee would, however, lead to a higher capital outflow initially, but would increase capital inflows in due course.
The intervention of the IMF is essential to ensure these favorable developments, as in 1977, when the economy was revived by the devaluation of the rupee and the liberalization of trade and payments. The president’s statement that following his discussions with the International Monetary Fund, he has decided to work with the IMF may be the most important step in the right direction.
Asking for help from the IMF is the way to go to stabilize our finances and start an economic recovery. The foreign exchange, fiscal and monetary reforms that such a decision entails would be extremely painful and politically difficult.
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