By Hema Senanayake –

Hema Senanayake

Usually I write on economic issues, especially on macroeconomic issues. Very rarely I write something of common interest. That is why I dedicated my previous piece to write something about BBS. However this essay is on economics or the impending economic calamity of Sri Lanka. Forecasted GDP growth has now been reduced.

At the beginning of this year the Central Bank of Sri Lanka (CB) forecasted that the country would achieve 7.5% of GDP growth. International Monetary Fund (IMF) forecasted 6.8% GDP growth. RMB Senanayake writing to Colombo Telegraph in January this year said that “So the growth rate projected by the Central Bank of 7.5% is possible but is it desirable for it risks a larger current account deficit…”

Rejecting all the above notions I wrote that “Sri Lanka will Never Achieve The Projected 7.5% GDP Growth” (Colombo Telegraph, January 26, 2013). My forecast was that GDP growth would be just above 5% if the government tried to stick to the limit of foreign borrowing proposed in the approved budget for 2013.

A few days ago, IMF slashed its GDP growth forecast to 6.3% from 6.8%. On May 09, 2013 DailyFT reported “the IMF projects Lankan economy to grow by 6.3% this year …. The growth forecast for this year is 0.5 lower than that was predicted in IMF’s October 2012 World Economic Outlook.” Is this a sign that finally my forecast is going to be accurate? Anyway I hope not.

Now you might be thinking how on earth I did my forecast. The answer is that I saw something that those experts at CB, Treasury and IMF did not see. Isaac Newton once suggested that if you want to see beyond what others saw then you must climb up and stand up on the shoulders of giants. This means “one who develops future intellectual pursuits by understanding and building on the research and works created by notable thinkers of the past.  That was what I did.

By doing that as far back as January 26, 2013 I wrote “… the government proposed in the budget for 2013 to reduce borrowing from foreign sources to Rs.86 billion which roughly amounts to $675 million from Rs.205.6 billion in 2012, which roughly amounted to $1.6 billion. This means that the government borrowed 2.5 times more in 2012, in U.S. dollar terms than the amount what is proposed to borrow for 2013. Still with such a higher amount of foreign loans, it has now been estimated that final GDP for 2012 came down to 6.5% from the estimated 8%. …The reduction of foreign borrowing to $675 million is very unrealistic … So, by proposing to reduce foreign borrowings dramatically the government has now set the presence of the first necessary condition to create a balance of payment crisis…” (Colombo Telegraph, Jan. 26, 2013)

So far the predicted balance of payment crisis was averted by drastically reducing the credit growth in the private sector.

The macro economy is a system; when you make a change in one area that affects to another area of the economy. For an example, if private credit is allowed to grow excessively then it might eventually destabilize the exchange rate of the rupee, in other words the rupee will get depreciated. Also if you drastically reduced the growth of private credit, then it will appreciate the rupee, foreign exchange reserves might go up even though such foreign reserve surges are not available for the government to use and finally the growth of GDP will be reduced to a disappointing figure. That is what has happened now; foreign exchange reserves up, GDP slashed.

My prediction was not ad-hoc, because I invited the readers of CT to keep an eye on my prediction. “Please note that the government did not propose to borrow from international commercial market this year; a promise that the government cannot keep if it wants to avoid a financial crisis. Hence the predicted GDP growth of 7.5% for this year will depend on the government’s ability to borrow heavily in USD terms, beyond the limit specified in the approved budget, period. I kindly request readers to keep an eye on my above prediction” (CT. January 26, 2013)

By the end of February this year, a high level delegation of IMF visited the country. Everybody now knows that the Treasury Secretary asked for a USD 1 billion as a budget support and such borrowing was not specified in the budget for 2013. Is this tantamount to a professional blunder done by the CB and the Treasury? I do not know but however the IMF had rejected the government’s request for a loan of USD 1 billion.

If the government wants to increase GDP along with the government’s revenue, it has to facilitate private sector credit growth. When private credit grows, foreign exchange reserves dwindle because imports are supposed to go up with the increase of private credit but GDP increases. Let me explain this point with a simple example.

Gross Domestic Product (GDP) is calculated in adding up four parameters. GDP = C+I+G+NE; in this simple equation C is consumption, I is investment, G is government expenditure and NE is net exports (i.e. exports-imports). Let us assume that CB removed the presently imposed credit growth limit to housing sector. As a result banks will issue more loans to home builders. Housing sector will require certain imported materials hence with the issuance of housing loans, imports might go up.

When the housing sector increases imports the value of NE reduces because NE = exports – imports. But at the same time local investments that is “I” in the GDP equation also go up. Housing loans increase certain imports and contribute negatively to NE and hence NE reduces but on the other hand housing construction contributes to increase “I” in the GDP equation, more than the reduction in NE and hence issuance of housing loans are very positive on GDP.

This means if balance of payment situation can be maintained the issue of housing loans will increase private credit growth but also increase GDP. Houses serve the well-being of lives especially in N&E given the devastation that took place during the war.

Now mega projects increases GDP too. Any expenditure of the government is added to GDP under the variable of “G” in the GDP equation but increases imports too. Eg; Mihin Air increases “imports” (or increases the outflow of dollars) but serves nothing for the well-being of the general public and contributes to destabilize rupee. That is why the government’s expenditure (which is “G” in GDP calculation) must be well spent. But the important point is “imports” is an economic activity but it does not necessarily increase the GDP. That is why professional prudence is very vital in the handling of economic policy; in fact economics is a science and it cannot be reduced to a daily decision making business.