By Hema Senanayake –
This refers to RMB Senanayake’s response to Chandra Jayaratne. Chandra Jayaratne requested professional economists to explain whether Sri Lanka can achieve per capita GDP of $ 10,000/= by 2022 as claimed by Minister S.B Dissanayake. RMB Senanayake concluded as follows:
“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 which if there are not adequate foreign capital inflows could cause a serious balance of Payments crisis.”
I do not agree with this conclusion since it intimates that if the government takes the risk to have a larger current account deficit that Sri Lanka will achieve 7.5% growth for 2013. On the contrary my conclusion is that the country will never achieve a GDP growth of 7.5% for this year under the proposals made in the budget. Why I am saying this?
A fundamental principle in modern science is that “nothing will happen without the presence of necessary conditions.” The same principle applies in economics. The government has made the presence of necessary conditions to create a virtual balance of payment crisis in this year too. As a result we will never achieve the projected GDP growth of 7.5%.
Firstly, 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 whole dynamic and the high expectation for higher GDP growth changed with the balance of payment crisis triggered in the first half of last year. Finally the year 2012 ended up with heavily depreciated rupee and a GDP growth of around 6.5%. The reduction of foreign borrowing to $675 million is very unrealistic given the fact that foreign debt service payments amounts to $ 1.54 billion. 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.
But the government can avoid a balance of payment crisis if foreign direct investments (FDIs) are increased. But treasury secretary Dr. Jayasundera already admitted that FDIs down by 50% in 2012. The U.S. has already warned that foreign investors would be away from Sri Lanka if the independence of judiciary is not ensured. Apart from that the government killed the entrepreneurial enthusiasm by bringing the Expropriation Act in 2011. Foreign investors usually work with local partners and the capable local entrepreneurs are now downhearted. Given these factors there will not be a dramatic increase in FDIs in 2013. So, we now have the second necessary condition set in motion to create a balance of payment crisis.
Also if export sector does well, it helps to avoid a balance of payment crisis, as exports bring in dollars. Sri Lanka lost GSP facility granted by EU; this means potential exports to euro area cannot be realized than otherwise. Still major western economies are struggling to recover after the Great Recession of 2008. Increase of exports significantly to these main trading partners is not a possibility. So exports would remain stagnant or grow mildly. So we set the third necessary condition.
However, Sri Lanka can avoid a balance of payment crisis if expatriate workers increase their remittances hugely. Foreign remittances are still steady and likely to grow by around 20%. This is the only favorable factor that the government can rely upon. But this increase will not offset the reduction of borrowings, the reduced inflow of FDIs and stagnant exports.
Also if foreign purchases of stocks are more than the foreign sales then the country will have a net inflow of dollars; but this is limited to a couple of hundred million dollars in the best case scenario.
Apart from the above sources, banks’ foreign borrowings will bring in dollars to the country. My guess is that this year bank borrowing from foreign sources will be less than the previous year. Some times BOI companies do borrow in dollars. This also helps to bring in a couple of million dollars.
Those are the main factors that affect the balance of payment of the country. Out of these you see that government foreign borrowings play a huge role. If government did not increase foreign borrowings by 2 to 3 times than the proposed limit in the budget for 2013 then the government has to contain the private sector credit growth to an unprecedented low level to prevent a balance of payment crisis. In the event, it reduces the private sector economic activity and the resultant effect is the drastic reduction of GDP growth, probably below 5%. If credit growth is not reduced then there will be a balance of payment crisis that too will reduce the growth.
That is why I conclusively say that the government already risks a balance of payment crisis for 2013. The only way to avoid such a crisis is to borrow more, from foreign sources. Deviating from the approved budget for 2013, it has already been reported that Dr. P.B. Jayasundera is going to ask IMF to grant a new loan of $1 billion; compare this amount with the amount mentioned in the approved budget which is nearly $675 million.
Luckily for the government IMF is not weighing the independence of judiciary when approving loans. Let us assume that IMF would approve a loan of $1 billion, still I guarantee that this amount will not be sufficient to avoid a full scale rupee crisis. The government will have to borrow from the international commercial market too. 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.
Alternate strategy is to get GSP facility to increase exports, increase FDIs, facilitate expatriate remittances and expatriate worker investments, to have non-manipulative stock market etc.; none of these are possible without us returning back to a functioning democracy; post war euphoria of economic growth prematurely ended due to bad governance.