In the previous article we discussed the importance of international trade in modern economies and the need to have a reserve currency, i.e., US Dollars , to facilitate international transactions. In this article we discuss one of the reasons for the current Dollar shortage experienced in the economy. As explained earlier there is an inflow of Dollars in to the economy and outflow of dollars from the economy. Whenever the inflow is greater than outflow, the foreign reserves grow and when the outflow is greater than the inflow reserves decline. Total foreign reserves in Sri Lanka increased substantially since 2008 and remained around $6-8 billion from 2014 to 2019. Since 2020, Sri Lankan economy experienced a sharp decline in reserves as shown in Figure 1. This decline is due to reduction in inflows while outflows were increasing.
Figure 1: Foreign Reserves in Sri Lanka $ Billion
Dollar inflows consist of export earnings, income from tourism, remittance, foreign direct investments (FDI), capital inflows and external borrowing. Let’s analyze at export earnings first. In analyzing the performance of the export sector, one can use many indicators. Growth in export earning is one such indicators. This indicator compares the current years export earning with the previous year data. Data from 2013 to 2020 shows that the export sector grew at an average rate of 3.5%, and it shows a sharp decline in 2020. This decline in 2020 is due to the impact of Covid-19. Growth of export earnings by 3.5% is inadequate in an economy with average rate of economic growth of about 5.5%. Because higher rate of economic growth will stimulate consumption and part of which will be met through imports. Unless adequately compensated by remittance, FDI and tourism income, this imbalance may require the country to opt for external borrowing to get sufficient amount of dollars to meet the import expenditure. Borrowing to finance imports will only provide a temporary relief. Unless the inflow of dollars is augmented, loan repayment will further reduce the dollar reserves in the country.
Export earnings as a percentage total output of the country (gross domestic product, GDP) is a is a better indicator to examine the performance of the export sector. In 1960, our export earnings were about 30% of GDP and it slowly increased to about 40% by 2000 and then steadily declined to about 20% of GDP by 2018 (Figure 2). Due to the impact of Covid-19, export earnings further dropped to about 15 % in 2020. More recent data suggest export earnings are improving but getting back to pre-pandemic level in not sufficient to support the dwindling reserves. Unfortunately, exports in a country cannot be increased overnight.
Thus, the export sector didn’t grow in line with the economic growth in the country. During the same period (1960 to 2020) export earnings grew rapidly in many Asian Countries; for example, in Vietnam to over 90% of GDP and in Cambodia to over 50%. In comparison to the average of the lower middle income countries Sri Lanka have been doing slightly better but since 2005, its export earnings as a % of GDP became lower than that in comparable middle-income countries. These data clearly shows that our export sector has been stagnant throughout the post independent history.
A careful examination of the export composition reveals that apparels sector contribute heavily to our export earnings. Up to 1980, tea and other agricultural export contributed about 52% of the exports and it came down to 19.8% in 2016. During the same period the apparels sector’s contribution increased to about 45 %. From the manufacturing category of exports, about 75% is contributed by apparels. Contribution to net dollar inflow by apparels sector is low because the clothing materials are imported and Sri Lanka’s value addition is mainly labor. Therefore, underneath the stagnant export sector is the inadequate industrialization. In the Sri Lankan economy, historical data shows that agriculture sector’s contribution declined over time and service sector expanded while industrial growth was stagnant. In comparison to export oriented industrial expansion, service sector expansion may not bring Dollars to the country, unless we export the services.
Imports and Trade Deficit
As explained above, one of the most important sources of Dollar inflows to the country, export earnings, have not been growing sufficiently for a long time. The opposite, import expenditure, one of the major sources of Dollar outflows, was growing at a faster rate. Therefore, the trade balance (export earnings minus import expenditure) has been consistently negative during the post independent period. As the Figure 3 shows, the trade deficit has been widening over time. Therefore, Sri Lanka has been losing more dollars than it gaining through the international trade. This has been a long-term imbalance in the economy. Therefore, coming out of the pandemic will not provide a quick fix to dollar shortage originated through international trade.
Figure 3: Exports, Imports and Negative Trade Balance, $ million
During the 1960-2020 period average trade deficit was 7.3% of the GDP. During the Pandemic, the trade deficit declined. However, it came down only to 6.36% in 2020. Since September 2021 trade deficit started to increase again. This was surprising because since 2020 the Government imposed severe import restrictions and allowed only the import of essentials. Dollars were not released for importing many commodities including petroleum products, milk power, fertilizer, cars etc. With those restrictions how does the trade deficit increased? Despite restrictions and forex shortage, 2021 imports figure soars by 28.5%; highest in three years. Import of textiles and textile articles, machinery and equipment, base metals, medical and pharmaceuticals, chemical products and plastics have mainly contributed to the rise in import expenditure.
Sharp increases were also observed in importation of rubber and rubber articles, telecommunication devices, home appliances, food and beverages, non-food consumables, clothing and accessories. This shows that Government attempt to control import to maintain reserves and to reduce pressure on Rupee devaluation is not working. On the other hand, given that petroleum product imports have a lion’ share in the import expenditure, trade deficit will further increase with the increasing oil prices. End result would be either reducing the already depleted reserves or shortages of many essential consumption goods, more fuel shortages and power cuts.
Will the End of Pandemic Augment the Export Earnings?
What did we learn from this discussion?. First, to maintain a healthy economy, i.e., to maintain sufficient amount of Dollar reserves, a country has to maintain sufficient rate of growth in export earnings. Sri Lank has not been able to do that. Reasons may be many. Poor governance, variety of reason which discourage FDI for the industrial sector, policy uncertainty and the heavy hand of the government and insufficient attention of the long-term repercussion of insufficient growth in the export sector by policy makers are few obvious reasons. More research on this is useful as there are lots of information gaps. End of the pandemic will perhaps bring the export earnings to pre pandemic levels but as explained above it is not sufficient to augment the reserves.
Second, poor performance of the export sector cannot be attribute fully to the pandemic, pandemic only aggravated the problem. Unless the underline reasons are fully understood and necessary reforms are not undertaken on a timely manner export sector will continue with its poor performance.
Third, ignoring the economic crisis and not resolving the debt crisis is further undermining the industrial sector in the country. Apparel sector apparently was able to import the main raw materials but the plight of micro, small and medium enterprises (MSME) is different. Many SMMEs are complaining about shortages of imported inputs for their industries. Statistics are not available on the impact of lack of chemical fertilizer and agrochemical for the Tea and other agricultural exports. Current power cuts and fuel shortages will affect industrial sector adversely. Therefore, continuation of the current crisis without decisive steps to resolve them will further undermine already poorly performing export sector.
One cannot understand the Dollar shortage fully by looking at only the exports and imports. We have to analyze the other Dollar inflows such as remittances, tourism, and FDI to get a comprehensive picture. In addition, we have to analyze another very important factor, external borrowing and loan repayments, which have compounded the dollar shortage originated due to poor performance of the export sector.