There is hope for a significant improvement in external finances this year owing to a likely improvement in the trade balance and higher earnings from tourism and other services. The likely IMF loan facility of US$ 1.5 billion will not only strengthen the depleted foreign reserves, but also would enhance international confidence in the stability of the Sri Lankan economy. However, the pursuance of correct monetary, fiscal and exchange rate policies are a necessary condition for the improvement of the external finances.

 Trade deficit
The trade balance is likely to improve by about 10 percent mainly due to a curtailment of imports achieved by a mix of monetary and fiscal policies, and the depreciation of the currency that has made imports dearer. Imports have been decreasing at a higher rate than the reduction in export earnings, thereby reducing the trade gap.

It is likely that imports would be reduced by over 10 percent from US$ 19.8 billion to about US$ 17 billion. The current global environment is not conducive to an increase in exports of a significant amount. However, there is prospect of some improvement in exports in the latter half of the year owing to the expected granting of the GSP plus facility and recommencement of fish exports to the European Union. If these developments were to occur, then the trade deficit could be brought down from US$ 8.4 billion in 2015 to about US$ 7.5 billion this year.

 Remittances and tourism
A trade deficit of about US$ 7.5 could be offset by workers’ remittances and earnings from tourism. Although remittances declined marginally by 0.5 percent last year from US$ 7 billion to US$ 6.9 billion, the first two months of this year have seen an increase in remittances by 8 percent as per the Central Bank.

Tourist earnings that have been on an increasing trend in the recent past,rose by 20 percent in 2015 and this trend has continued into the first three months of this year. Earnings from tourism could be expected to increase to more than US$ 2.5 billion this year.

With workers’ remittances of at least US$ 7 billion, earnings from tourism of at least US$ 2.5 billion and a trade deficit of US$ 7.5 billion, there would be a Balance of Payments (BoP) surplus of over US$ 2 billion. This surplus could be further underpinned via earnings from services, especially ICT services that have also been increasing in recent years.
The IMF loan facility which would not only strengthen the country’s depleted reserves, but add considerable international confidence in the Sri Lankan economy, would checkcapital outflows that were a feature last year. It would also reduce the cost of international borrowing. Although the exact provisions of Chinese financial assistance is not yet clear, the financial and investment ties with China, too would enhance the external reserve position in the course of time.

Cautious optimism
This improvement in external finances must be carefully guarded. Continued prudent economic management could improve finances much better than the scenario outlined above. Policy recommendations to increase government revenue and reduce the fiscal deficit are core recommendations of the IMF that must be followed.  Key objectives underlying the reform agenda include: (i) improving revenue administration and tax policy; (ii) strengthening public financial management; (iii) state enterprise reforms; and, (iv) structural reforms to enable a more outward-looking economy, deepen foreign exchange markets, and strengthen financial sector supervision.”

These reforms may not be easy to achieve due to political opposition, trade union pressures and weak administration. Nevertheless, achieving the above may improve the fiscal situation. One must hope that the cabinet decision to reduce the 2016 fiscal deficit to 5.4 percent of GDP would be achieved with appropriate policies.

The IMF statement of April 5,  2016 clearly emphasizes the need for stringent application of the recommended policies. “Achieving medium-term growth and reserve objectives and building greater resilience to external shocks will require a renewed effort toward greater integration into regional and global supply chains, higher levels of foreign direct investment, and enhancing prospects for private sector investment.” Are we at the threshold of reforming the economy?