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Need To Maintain Flexible Exchange Rate

Jul 23, 2011 3:13:16 PM - thesundayleader.lk

Sri Lanka may have to adopt a flexible exchange rate if it’s to meet the IMF target of a US$ 135 million balance of payments (BoP) surplus by the year end.

IMF Resident Representative Dr. Koshy Mathai speaking on the economy in an interactive seminar on Thursday said that with the rise in imports there however may be a possibility that the country might end up with a BoP deficit. Previously remittances helped to swell reserves. In 2009 due to the recession where prices fell, and so also the island’s import bill (especially that of oil), Sri Lanka ended up with a BoP surplus of US$ 2.9 billion, he said.

Asked whether the IMF would waive off this BoP target on the basis of external shocks such as the Middle East crisis and the threat that that poses to tea prices and remittances, he said that the answer to that was to have a flexible exchange rate.

Central Bank of Sri Lanka (CBSL) in order to stabilise the rupee has been both buying and selling US dollars from and to the market. But Mathai wanted the exchange rate to perform more freely, rather than being administered.

Sri Lanka has received tranches totalling US$ 1.6 billion from its US$ 2.4 billion standby arrangement  with the IMF, with the balance US$ 800 million to be disbursed in two equal tranches of US$ 400 million each based on meeting  set monetary and fiscal targets for the half years ended/ending June 30, 2011 and December 31, 2011 respectively.

Mathai said that he is not in receipt of the June figures but said that the budget deficit was on target to end up at 6¾% of GDP.

He further said that it was alright for CBSL to sell dollars to the primary market and thereby reduce excess rupee liquidity. Previously they bought dollars and swelled the market with rupees in lieu, said Mathai.

On the issue of unfocused development, especially in relation to the development that is taking place at Hambantota, he said that the IMF’s mandate is on fiscal and monetary numbers.  Agencies like the World Bank may be in a better position to answer such questions, he said.

Mathai however said that Institute of Chartered Accountants of Sri Lanka (ICASL) President Sujeewa Mudalige had told him that the US$ 4½ -5 billion that is to be pumped into Hambantota in relation to the Commonwealth Games was in anyway development that was marked for the district. It’s being speeded up.

The seminar was organized by ICASL.

Mathai said that Sri Lanka spends 6% of GDP (US$ three billion) on capital investments. As the country’s GDP grows that absolute value also increases, he said.

He further said that the country needs a second airport. But he was not sure whether it should be located in Mattala or not. Mathai said that Sri Lanka’s infrastructure was so poor that it was badly in need of development. A foreign cricket team refused to travel to Dambulla because of the poor state of the island’s roads.

He also said that Sri Lanka should increase its exports regionally. Only 6% of its exports go to the growing economies of India and China, said Mathai, whereas 56% go to the EU and USA where their share in the world’s GDP is however diminishing, whereas that of emerging economies led by India and China are increasing.

Sri Lanka’s exports to Asia account for 10% of its total exports.

“The Western consumer is no longer the engine of growth,” he said. EU and the USA are slow growth engines.

Mathai said that the Comprehensive Economic Partnership Agreement  with India was a must to boost exports. He said that though the ICASL opposes it, only a few sectors, where Sri Lanka doesn’t have the sufficient skills will be open to the Indians.

Sri Lanka’s exports have fallen from 30% of GDP to 15% of GDP over the years and its share in world’s exports from 0.08% to 0.06%. Sri Lanka must retrieve that lost 0.02%, he said. Mathai said that the island should move away from its dependency on garments and tea exports  (comprising 51% of export revenue cumulatively) and concentrate on increasing exports in other sectors such as IT/BoP (currently 1%), tourism (3%) and other industries (28%).

Sri Lanka’s value added exports are low.

He further said that there was a correlation between an improved doing business climate and increased foreign direct investments. There was also a correlation between high budget deficits and high public debt vis-à-vis the crowding out of credit to the private sector.

But he said that steps are being taken by the Government to reduce the budget deficit and public debt.

Mathai also said that there is a difference between the cost of living (CoL) and inflation. He said that inflation is the measurement of year on year increase in prices. However, if prices start from a higher base, even a marginal increase in inflation does have an impact on the CoL, he said.

Mathai said that with rising commodity prices led by oil, there were expectations that inflation would increase globally. He said core inflation would not be a realistic measurement of inflation for poor countries where much of the income is spent on food. Core inflation takes out food and energy prices in inflation measurement so as to find out what tools central banks world over could use to tame core inflation.

Measurement of core inflation is good for wealthy countries, said Mathai.

He further said stable exchange and interest rates and inflation were essential to attract investments. He also emphasized the importance of developing the corporate bond market. “In Malaysia the value is nearly 50% of GDP, but of Sri Lanka’s it is a mere Rs. 30 billion or under 1% of GDP,” he said. The need for bank credit to grow was also emphasized when the corresponding GDP figures were compared with other emerging economies. China’s bank credit is 100% of GDP, said Mathai.

A high public debt and a high fiscal deficit may be the reasons for this, he said. Due to limited budgetary space, he also stressed the importance of public-private partnerships to spur development.

Mathai was supportive of the Government’s thrust to borrow long term from international capital markets provided such monies raised are used to retire expensive short term debt.