"Sri Lanka is bound to start feeling some of the impacts of a slowdown in the global economy—not only through trade flows but also through financial and investment links—while having to continuously grapple with international commodity prices," says a report released by the Institute of Policy Studies (IPS). The fall in US consumption, a result of the credit crunch which saw the US government raise US$ 700 billion in an attempt to bail out its financial system, is not entirely discouraging for Sri Lanka says the report, ‘Sri Lanka: State of the Economy 2008’. It says that asset price falls in the US will effect consumption of durable goods to a greater extent than non-durable goods. "The majority of Sri Lanka’s exports to the US are non-durable goods, particularly apparels (which accounts for 81 percent of Sri Lanka’s exports to the US)," the report says. About 25 percent of Sri Lanka’s exports in 2007 was to the US, and although declining the US remains the biggest market for apparels. The report says that according to the US Bureau of Economic Analysis statistics, consumption of durable goods fell by 1.5 percent between the fourth quarter of 2007 and first quarter of 2008, while consumption of non-durables fell by 0.3 percent. However, expenditure on clothes and shoes increased by 0.2 percent. But the report raised concerns that non-durable consumption growth in the US has slowed down significantly since 2007. When the report was prepared it was too early to predict the economic crisis the EU is in now. In 2007, about 37 percent of Sri Lanka’s exports were to the EU with a third of these to the UK. The slowdown of UK’s economy and its shaky financial system is a major concern for Sri Lanka as the report says that the country’s housing bubble had been larger than that in the US. "The financial sector (in the UK) has been adversely affected, reflected by declining equity prices on major financial institutions. "As the financial sector is the engine of the UK economy a decline will have ripple effects across its economy," the report says. Earlier this year, many multilateral institutions and economists believed that developing countries no longer relied on developed countries as a result of the emergence of China and India as economic powerhouses. However, the IPS report says that some countries, including Sri Lanka, continued to rely on developed countries for export markets. "Financial markets in Sri Lanka are largely unaffected by the sub-prime crisis," the report says. "The major impact of a downturn in advanced economies is likely to be transmitted through the trade channels," the report said. Boosting intraregional trade and enhancing links to ASEAN and China is viewed by many economists and analysts as a way of minimizing the impact of declining exports to the US and EU and to gain lost ground or even more. FDIs However, it says that foreign directed investments (FDI) could be constrained in the short term as access to capital has declined together with the risk appetite of investors tempering in the short run. "However, encouragingly for Sri Lanka, FDI in the recent past has been dominated by developing nations- particularly Malaysia and India," it says. The report goes on to say that the continued dominance of emerging economies and the down-turn in developed markets could shift investments from developed markets towards developing economies in the short term. Foreign commercial borrowings However, the government’s trend to resort to foreign commercial borrowings, in the face of dwindling aid as Sri Lanka is no longer classified a low-income country, has raised concerns that the country’s vulnerability to external shock has been increased. "With domestic rates high foreign borrowing may be cheaper for the government," the report says. It could also mitigate the upward movement of interest rates by not demanding for domestic credit. The report says, however, that the dominance of foreign debts will require that Sri Lanka repays a large sum of money in one payment at a fixed date. With the global financial crisis, raising foreign commercial loans to service these debts is going to be costly. Long term commercial borrowing increased from US$ 56 million in 2004 to US$ 630 million in 2007, the report says. "With further pressure on government finances, the government decided to further expand sources of external finance by allowing foreign purchases of up to 5 percent of the value of outstanding Treasury bonds in 2006," it says. In December 2007 the limit was expanded to 10 percent. "By the end of 2007, investment in Treasury bonds reached US$ 373 million (more than the total multilateral aid received by Sri Lanka in 2007). "The maturity of these bonds was between 2 to 11 years and the average yield was 14 percent," the report says. In 2006, the government raised US$ 680 million through dollar bonds maturing in 2 to 3 years and syndicate loan. The sovereign debt issue of US$ 500 million is to be repaid in 5 years at 8.25 percent. The government has raised about US$ 800 million from foreign sources this year and hopes to raise a further US$ 300 million syndicate loan. "The share of foreign financing of the budget deficit has increased from 2.5 percent of GDP in 2006 to 3.7 percent in 2007, where the bulk of the increase has come by way of loans rather than grants," the report says. The report says the government’s strategy is to push ahead with easing the infrastructure bottlenecks impeding growth while continuing to spend on security, education and agriculture. It says that balancing these expenditures with medium term debt exposure is not without its pitfalls. "The prudent course has to be to restructure spending in other areas in order to minimize Sri Lanka’s recourse to costly borrowing," the report suggests. |
