Trade and budget deficits feed a debt imbroglio-Dark clouds on the economic horizon
Sunday 07 October 2012
Lanka in general, and GoSL in particular, are not yet in the grip of a deep economic crisis, but statistics recently released for the first seven months of year 2012 denote that the country is moving inexorably in that direction. An actual crisis may be on our hands as early as the first quarter of 2013, unless - well that’s the way people end sentences, but I don’t see the “unless”; what can this government do that will not buckle its policy applecart? There are two fundamental problems, a foreign trade deficit that the government, despite some efforts, has been unable to surmount and a burgeoning budget deficit simply running wild. The manifestation of the two diseases is swelling sovereign debt which within a year or two may spell financial ruin. To repeat in different words, a mounting deficit on the foreign trade and services account, and rising budget deficits are the motor forces of a predicament whose manifest effect is forcing Lanka into a spiralling debt crisis. This is the picture that statistics for the first seven months of this year clearly paint.
I will devote this piece to explaining the condition of the patient and only add a paragraph at the end dissecting causes, allocating blame and suggesting an alternative policy.
Putting it in round numbers, which is the best we can do at this stage since the first seven months only provide a trend line for where we may be at the end of year 2012, import outgoings for this year will be about $21 billion and export earnings about $11 billion. With an aggressive policy of import discouragement the government may be able to reduce this mountain of a $10 billion deficit in the foreign trade account by a little, but not too much. Exports certainly cannot be grown by anything above trend by any policy formulations that can take effect within three months and in any case everyone is at the mercy of a contracting European market and a doggedly slack US economy. Hence it is reasonable to forecast that export earnings will only cover 50 to 60% of import expenditure and frankly I do not expect better in 2013. The Central Bank research unit’s forecasts in the accompanying figure are more pessimistic than mine.
If we are out of pocket to the tune of $10 billion on foreign trade and services how to balance the books and cook what cannot be balanced - that is reconcile the balance of payments. Remittances, that is what the ladies (and a few gentlemen) who work mostly in the Middle East send home, may reach $5 billion or with luck a little more in 2012. Tourism may with difficulty bring in another $1 billion. The government has pipe dreams of attracting foreign direct investment (FDI) to the tune of $1.7 billion in 2012 but this is pie in the sky, a significant shortfall is certain. All together this covers say $7 billion of the shortfall in the trade account. Short-term cash flows into portfolio accounts (stock market and private currency inflows) and bank borrowing of foreign currencies can help a bit, but in the end GoSL will resort to massive foreign borrowings by issuing sovereigns. Grants and the ever faithful IMF will help. I would not be surprised if GoSL’s total foreign indebtedness increases by a further $2 billion in year 2012.
Spiralling budget deficit
Recently released statistics show that the budget deficit for the first half of 2012 was a frightening 61% or 38%, depending on how you do your sums. The deficit of Rs303 billion for the first six months is 61% of revenue (Rs497 billion) or 38% of expenditure (Rs800 billion) for the same period. There is a theory of increased revenue flows in the second half of a year due to enhanced tax collections, but I think this is exaggerated; most tax is from excise duties, indirect taxes and customs duties and there is no reason to expect a large spike in revenue during the rest of the year.
It is reasonable to forecast that the government budget deficit for year 2012 will, in round numbers, be about Rs600 billion, while revenue and expenditure can be similarly pro-rated upwards to Rs1000 billion and Rs1600 billion, respectively. Obviously this is not formal forecasting but the numbers are good enough to convey a reliable flavour of the parlous state of economic health. How does this compare with last year? Quite bad; the end of year budget deficit for 2012 will be about 40% higher than the 2011 deficit; the half year deficits were Rs217 billion and Rs303 billion in the first six months of 2011 and 2012, respectively.
The debt mountain
Just as current account deficits have to be bridged by foreign borrowings, budget deficits have to be bridged by local, and when local sources run dry, by foreign borrowings. Last year the government sucked the EPF, ETF and NSB nearly dry, drawing 95% of its borrowing from these sources, not from private investors, so kiss your retirement goodbye if you are a young employee. Now it is turning increasingly to foreign sources to bridge the gap. The 2012 budget as approved by parliament specified that GoSL should borrow Rs780 billion from domestic and Rs330 billion from external sources, but it has now got its sums upside down; by the end of July it had tapped Rs380 billion from domestic and Rs650 billion from external sources. Come end December the government of Sri Lanka will exceed the Rs1100 billion borrowing limit set by parliament by a very large margin. By the end of July it had already reached 93% of that limit.
Is it surprising then that 40% of the funds allocated in the 2013 expenditure statement have been set aside for debt servicing? GoSL is now in the business of acquiring debt to service existing debt, which is a way of digging oneself ever deeper into a hole since one is not just taking new debt to pay off maturing debt; one is also assuming new debt to pay interest falling due on existing debt. GoSL’s total debt at the end of July stood at Rs6200 billion which is over 80% of my estimate of 2012 GDP.
En passant observe that the Central Bank has step by step lowered its 2012 GDP growth forecast from 8% to 6.8% which I believe is still too high. To be realistic, keep a growth rate below 6.5% in the back of your mind. Though the Central Banks goes on about Rs7500 billion GDP (in devalued rupees) in 2012 compared to non-devalued Rs6550 in 2011, in dollar terms it will increase from $59 billion only to about $63 billion in 2012 over 2011.
From the beginning of the GoSL-IMF deal more than two years ago I have consistently maintained that stories of slashing budget deficit to 6.2% of GDP and lowering the total sovereign debt to 65% of GDP were fairy stories. I believe that palpable trends have now vindicated my doubts. The basic error in government economic policy is that it is chasing a financial miracle of Asia myth, relying on soft and volatile sectors like tourism, and putting numerous eggs in a grandiose white-elephant basket. This strategy has failed; the way out is to shift out of what my friend Sumanasiri Liyanage calls shallow development and turn to growing the real economy of industry, agriculture and real services, not the financial economy and soft sectors.
Sunday 07 October 2012
Lanka in general, and GoSL in particular, are not yet in the grip of a deep economic crisis, but statistics recently released for the first seven months of year 2012 denote that the country is moving inexorably in that direction. An actual crisis may be on our hands as early as the first quarter of 2013, unless - well that’s the way people end sentences, but I don’t see the “unless”; what can this government do that will not buckle its policy applecart? There are two fundamental problems, a foreign trade deficit that the government, despite some efforts, has been unable to surmount and a burgeoning budget deficit simply running wild. The manifestation of the two diseases is swelling sovereign debt which within a year or two may spell financial ruin. To repeat in different words, a mounting deficit on the foreign trade and services account, and rising budget deficits are the motor forces of a predicament whose manifest effect is forcing Lanka into a spiralling debt crisis. This is the picture that statistics for the first seven months of this year clearly paint. I will devote this piece to explaining the condition of the patient and only add a paragraph at the end dissecting causes, allocating blame and suggesting an alternative policy.
Putting it in round numbers, which is the best we can do at this stage since the first seven months only provide a trend line for where we may be at the end of year 2012, import outgoings for this year will be about $21 billion and export earnings about $11 billion. With an aggressive policy of import discouragement the government may be able to reduce this mountain of a $10 billion deficit in the foreign trade account by a little, but not too much. Exports certainly cannot be grown by anything above trend by any policy formulations that can take effect within three months and in any case everyone is at the mercy of a contracting European market and a doggedly slack US economy. Hence it is reasonable to forecast that export earnings will only cover 50 to 60% of import expenditure and frankly I do not expect better in 2013. The Central Bank research unit’s forecasts in the accompanying figure are more pessimistic than mine.
If we are out of pocket to the tune of $10 billion on foreign trade and services how to balance the books and cook what cannot be balanced - that is reconcile the balance of payments. Remittances, that is what the ladies (and a few gentlemen) who work mostly in the Middle East send home, may reach $5 billion or with luck a little more in 2012. Tourism may with difficulty bring in another $1 billion. The government has pipe dreams of attracting foreign direct investment (FDI) to the tune of $1.7 billion in 2012 but this is pie in the sky, a significant shortfall is certain. All together this covers say $7 billion of the shortfall in the trade account. Short-term cash flows into portfolio accounts (stock market and private currency inflows) and bank borrowing of foreign currencies can help a bit, but in the end GoSL will resort to massive foreign borrowings by issuing sovereigns. Grants and the ever faithful IMF will help. I would not be surprised if GoSL’s total foreign indebtedness increases by a further $2 billion in year 2012.
Spiralling budget deficit
Recently released statistics show that the budget deficit for the first half of 2012 was a frightening 61% or 38%, depending on how you do your sums. The deficit of Rs303 billion for the first six months is 61% of revenue (Rs497 billion) or 38% of expenditure (Rs800 billion) for the same period. There is a theory of increased revenue flows in the second half of a year due to enhanced tax collections, but I think this is exaggerated; most tax is from excise duties, indirect taxes and customs duties and there is no reason to expect a large spike in revenue during the rest of the year.
It is reasonable to forecast that the government budget deficit for year 2012 will, in round numbers, be about Rs600 billion, while revenue and expenditure can be similarly pro-rated upwards to Rs1000 billion and Rs1600 billion, respectively. Obviously this is not formal forecasting but the numbers are good enough to convey a reliable flavour of the parlous state of economic health. How does this compare with last year? Quite bad; the end of year budget deficit for 2012 will be about 40% higher than the 2011 deficit; the half year deficits were Rs217 billion and Rs303 billion in the first six months of 2011 and 2012, respectively.
The debt mountain
Just as current account deficits have to be bridged by foreign borrowings, budget deficits have to be bridged by local, and when local sources run dry, by foreign borrowings. Last year the government sucked the EPF, ETF and NSB nearly dry, drawing 95% of its borrowing from these sources, not from private investors, so kiss your retirement goodbye if you are a young employee. Now it is turning increasingly to foreign sources to bridge the gap. The 2012 budget as approved by parliament specified that GoSL should borrow Rs780 billion from domestic and Rs330 billion from external sources, but it has now got its sums upside down; by the end of July it had tapped Rs380 billion from domestic and Rs650 billion from external sources. Come end December the government of Sri Lanka will exceed the Rs1100 billion borrowing limit set by parliament by a very large margin. By the end of July it had already reached 93% of that limit.
Is it surprising then that 40% of the funds allocated in the 2013 expenditure statement have been set aside for debt servicing? GoSL is now in the business of acquiring debt to service existing debt, which is a way of digging oneself ever deeper into a hole since one is not just taking new debt to pay off maturing debt; one is also assuming new debt to pay interest falling due on existing debt. GoSL’s total debt at the end of July stood at Rs6200 billion which is over 80% of my estimate of 2012 GDP.
En passant observe that the Central Bank has step by step lowered its 2012 GDP growth forecast from 8% to 6.8% which I believe is still too high. To be realistic, keep a growth rate below 6.5% in the back of your mind. Though the Central Banks goes on about Rs7500 billion GDP (in devalued rupees) in 2012 compared to non-devalued Rs6550 in 2011, in dollar terms it will increase from $59 billion only to about $63 billion in 2012 over 2011.
From the beginning of the GoSL-IMF deal more than two years ago I have consistently maintained that stories of slashing budget deficit to 6.2% of GDP and lowering the total sovereign debt to 65% of GDP were fairy stories. I believe that palpable trends have now vindicated my doubts. The basic error in government economic policy is that it is chasing a financial miracle of Asia myth, relying on soft and volatile sectors like tourism, and putting numerous eggs in a grandiose white-elephant basket. This strategy has failed; the way out is to shift out of what my friend Sumanasiri Liyanage calls shallow development and turn to growing the real economy of industry, agriculture and real services, not the financial economy and soft sectors.
