The most pertinent question arising from the British exit from the European Union (Brexit) is the impact it would have on the Sri Lankan economy. In what ways will it affect our economy adversely? Higher interest rates that are likely to prevail for some time could increase our cost of international borrowing. If Brexit results in unfavourable economic conditions in Europe and Britain, it could affect the demand for our exports. Tourist arrivals from Britain and exports to Britain could be adversely affected by the depreciation of the sterling pound.
Higher cost of borrowing
The volatility in capital markets and higher international interest rates owing to global uncertainty could increase our cost of international borrowing. This is particularly significant as the country needs to borrow this year in order to meet its debt servicing costs. The downgrading of the country risk ratings has aggravated the problem. Foreign borrowing could be more difficult and expensive, and there could be adverse effects in the flow of investment till the situation stabilizes.
Britain being Sri Lanka’s second largest export destination, nearly 10 percent of the exports are to Britain, while nearly 30 percent are to the EU. If incomes fall in the UK and the EU, there can be a reduction of exports to these important markets. This income effect on our exports would be less in the EU than in Britain. The GSP plus concession the EU is expected to restore will not apply to Britain after it secedes from the EU. As per experts, it is likely that Sri Lanka would lose the concession, and this signals about the increased competition local exporters have to face in the global market now. What Sri Lanka should try now is to negotiate a trade agreement with Britain that would give similar concessions.
As our currency is pegged to the US dollar, the appreciation of the Sri Lankan Rupee vis-a-vis the UK pound sterling would increase the price of our exports to Britain, thus reducing our export demand. On the other hand, British imports to Sri Lanka would be cheaper.
Brexit has created an abrupt change in the global political and economic arena. It has come at a time when Sri Lanka’s external trade position is not at all good. The immediate effect of Brexit on Sri Lanka is that it has created a period of uncertainty, speculation and volatility in financial markets. As is usual in such circumstances, markets overreact immediately to stabilise later. The medium-term effects could however be different from the immediate responses that we have witnessed over the past few weeks.
Even if some commentators view Brexit to be not that significant to Sri Lanka, the country’s exports, tourism and investments could be adversely affected. This is due to reduced consumer spending in Europe as a result of weakened currency and falling incomes. Tourist earnings for Sri Lanka are likely to decline as it would be too costly for Europe to afford foreign travels.
The most significant adverse impact could be capital outflows and increased cost of foreign borrowing. This is crucial at the time since foreign borrowing is the only option Sri Lanka could attempt to fill her external gap. The volatility of global exchange rates and interest rates will undoubtedly impact on us. Export market diversification is one way to cope with the negative impact on Sri Lankan exports, according to experts.
Though international developments are beyond our control, Sri Lankan government and policymakers should manage our economic policies so as to be least affected by adverse global developments. Fiscal and monetary policies must ensure stability and be conducive to investment and growth. Fiscal discipline and prudent debt management are essential along with policymakers’ foremost attention to right macroeconomic fundamentals and a sound external position.