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BOP crisis: Acting late has very painful consequences
*Sharp fuel price increase in response to falling reserves position
A senior economist says Sri Lanka has tried to sweep under the carpet the chronic structural deficiencies of the balance of payments for far too long. When corrective policy decisions are taken too late, such as allowing more flexibility in the exchange rate and adjusting domestic fuel prices to reflect global realities, these adjustments would prove to be too painful to people of the country; the price we all have to pay for consistent flawed economic policy.
"The Central Bank has failed to maintain a controlled exchange rate regime and the government has failed to control fuel prices effectively for far too long. Although being the right policy decisions, allowing the exchange rate to adjust to market forces and fuel prices to global price movements, these will now be too painful adjustments to the people," the head of the Economics Department of the University of Colombo, Dr. Sirimal Abeyratne told The Island Financial Review.
For years economists have been warning the government that the exchange rate and fuel prices would have to be allowed to be more flexible in order to contain stresses on the balance of payments. But with reserves at low levels, the country has within a week relaxed its hold on the exchange rate, increased key policy interest rates and introduced ceilings on bank loans in a bid to contain high credit growth.
The sharp increase in domestic fuel prices is also a response to the falling reserves position in the face of severe import demand with the Central Bank selling more than US$ 2.5 billion since July 2011 just to keep the exchange rate stable. As at end November 2011, official reserves stood at US$ 6.2 billion and government debt amounted to US$ 4 billion, data released by the Central Bank last month showed, an indication that none-borrowed reserves were at a low level.
"All these adjustments are necessary but they came too late so now we will have painful consequences. Allowing the exchange rate to depreciate came too late and the fuel price adjustments had to be increased dramatically because smaller adjustments were not made earlier," Dr. Abeyratne said.
Dr. Abeyratne argues that the fuel price hike would have a one-off price adjustment across the economy.
"It would be a painful adjustment, but inflation may not be a problem because prices have to be continuously on the rise for several months. If domestic fuel prices were allowed to adjust to reflect global realities, the people would have benefited by low global prices, but this never happens either," he said adding that that there was a serious problem of efficiency with regard to refining and distributing fuel in the country, which have also been factored into the economy.
"There will be little the government can now do to soften the blow the people of this country would now feel. There is nothing wrong in having realistic prices, but when prices have been distorted for too long, adjustments would always be painful at first. Acting too late, which is the case today, the pain would be unnecessarily acute."
Economists and analysts point out that countries allowing domestic fuel prices to reflect global prices have better control over inflation.
Dr. Abeyratne was one of the first to highlight that Sri Lanka was heading for a balance of payments crisis in 2007. Credit growth was high and the Central Bank was maintaining a stable exchange rate by selling dollars in the face of a growing trade deficit. When global commodity prices increased sharply in 2008, the country had little space left to soften the blow because it had already been using its reserves to defend the rupee. Authorities had to turn to the International Monetary Fund for balance of payments support.
The end of the thirty-year conflict in May 2009 helped to stimulate foreign investment inflows into the country, which was largely short term ‘hot’ capital. Tranches from the IMF also helped boost the country’s reserve position, which was a little over US$ 1 billion at the beginning of 2009.
"Despite the IMF loan and favourable balance of payment positions since then, we have continued to sweep under the carpet structural deficiencies in our balance of payments and it was only inevitable that the problem would resurface sooner or later," Dr. Abeyratne said.
According to Dr. Abeyratne, the country’s current account is buoyed by worker remittances and not export earnings which have been on the decline as a percentage of the country’s GDP for decades. "This reflects the country’s poverty and not the ability to generate wealth by production," he said.
The capital account is dominated by foreign borrowings and not foreign investments.
"Therefore our balance of payments continues to suffer serious structural deficiencies which would require some rebalancing," Dr. Abeyratne said.
Apart from the one-off price increases to domestic goods, industrialists would also be hit by the increase in fuel prices.
"Industrialists will find there budgets going haywire and finances would come under stress," an analyst said.
Last Thursday, the rupee fell to Rs. 115.20/30 against the dollar, falling by more than one rupee after the Central Bank stayed away from the foreign exchange market. The rupee had held at Rs. 113.90 against the greenback a week earlier.
The International Monetary Fund has welcomed the Central Bank’s decision to allow the exchange rate to be more flexible and measures to contain credit growth. It said economic growth was expected to be rapid while inflation would remain under control. It has also called for a turnaround of loss making state enterprises, particularly the CPC and CEB, which means the fuel price hikes are a welcome measure as far as the IMF concerned.
http://island.lk/index.php?page_cat=article-details&page=article-details&code_title=45128
*Sharp fuel price increase in response to falling reserves position
A senior economist says Sri Lanka has tried to sweep under the carpet the chronic structural deficiencies of the balance of payments for far too long. When corrective policy decisions are taken too late, such as allowing more flexibility in the exchange rate and adjusting domestic fuel prices to reflect global realities, these adjustments would prove to be too painful to people of the country; the price we all have to pay for consistent flawed economic policy.
"The Central Bank has failed to maintain a controlled exchange rate regime and the government has failed to control fuel prices effectively for far too long. Although being the right policy decisions, allowing the exchange rate to adjust to market forces and fuel prices to global price movements, these will now be too painful adjustments to the people," the head of the Economics Department of the University of Colombo, Dr. Sirimal Abeyratne told The Island Financial Review.
For years economists have been warning the government that the exchange rate and fuel prices would have to be allowed to be more flexible in order to contain stresses on the balance of payments. But with reserves at low levels, the country has within a week relaxed its hold on the exchange rate, increased key policy interest rates and introduced ceilings on bank loans in a bid to contain high credit growth.
The sharp increase in domestic fuel prices is also a response to the falling reserves position in the face of severe import demand with the Central Bank selling more than US$ 2.5 billion since July 2011 just to keep the exchange rate stable. As at end November 2011, official reserves stood at US$ 6.2 billion and government debt amounted to US$ 4 billion, data released by the Central Bank last month showed, an indication that none-borrowed reserves were at a low level.
"All these adjustments are necessary but they came too late so now we will have painful consequences. Allowing the exchange rate to depreciate came too late and the fuel price adjustments had to be increased dramatically because smaller adjustments were not made earlier," Dr. Abeyratne said.
Dr. Abeyratne argues that the fuel price hike would have a one-off price adjustment across the economy.
"It would be a painful adjustment, but inflation may not be a problem because prices have to be continuously on the rise for several months. If domestic fuel prices were allowed to adjust to reflect global realities, the people would have benefited by low global prices, but this never happens either," he said adding that that there was a serious problem of efficiency with regard to refining and distributing fuel in the country, which have also been factored into the economy.
"There will be little the government can now do to soften the blow the people of this country would now feel. There is nothing wrong in having realistic prices, but when prices have been distorted for too long, adjustments would always be painful at first. Acting too late, which is the case today, the pain would be unnecessarily acute."
Economists and analysts point out that countries allowing domestic fuel prices to reflect global prices have better control over inflation.
Dr. Abeyratne was one of the first to highlight that Sri Lanka was heading for a balance of payments crisis in 2007. Credit growth was high and the Central Bank was maintaining a stable exchange rate by selling dollars in the face of a growing trade deficit. When global commodity prices increased sharply in 2008, the country had little space left to soften the blow because it had already been using its reserves to defend the rupee. Authorities had to turn to the International Monetary Fund for balance of payments support.
The end of the thirty-year conflict in May 2009 helped to stimulate foreign investment inflows into the country, which was largely short term ‘hot’ capital. Tranches from the IMF also helped boost the country’s reserve position, which was a little over US$ 1 billion at the beginning of 2009.
"Despite the IMF loan and favourable balance of payment positions since then, we have continued to sweep under the carpet structural deficiencies in our balance of payments and it was only inevitable that the problem would resurface sooner or later," Dr. Abeyratne said.
According to Dr. Abeyratne, the country’s current account is buoyed by worker remittances and not export earnings which have been on the decline as a percentage of the country’s GDP for decades. "This reflects the country’s poverty and not the ability to generate wealth by production," he said.
The capital account is dominated by foreign borrowings and not foreign investments.
"Therefore our balance of payments continues to suffer serious structural deficiencies which would require some rebalancing," Dr. Abeyratne said.
Apart from the one-off price increases to domestic goods, industrialists would also be hit by the increase in fuel prices.
"Industrialists will find there budgets going haywire and finances would come under stress," an analyst said.
Last Thursday, the rupee fell to Rs. 115.20/30 against the dollar, falling by more than one rupee after the Central Bank stayed away from the foreign exchange market. The rupee had held at Rs. 113.90 against the greenback a week earlier.
The International Monetary Fund has welcomed the Central Bank’s decision to allow the exchange rate to be more flexible and measures to contain credit growth. It said economic growth was expected to be rapid while inflation would remain under control. It has also called for a turnaround of loss making state enterprises, particularly the CPC and CEB, which means the fuel price hikes are a welcome measure as far as the IMF concerned.
http://island.lk/index.php?page_cat=article-details&page=article-details&code_title=45128
