Opinions on subjects of the day mainly as it pertains to common sense suggestions in improving the quality of life of all who are fortunate to live in this serendipitous island of Sri Lanka.
Saturday, June 23, 2012
Balance of Payments and Exchange Rate – Conspiracy of Silence or Wishful thinking – Enemies or friends? Treasury and Central Bank
We live through uncertain times. There is a lot of chatter and forecasts of what is to come. The pundits are not sure, but hope for the best. The reason for this is if the indicators come to pass, they may become toast! Or at least they should be if they are held accountable.
Heavy duties were imposed recently on all vehicles except those transporting goods and buses. The hope is that imports of such will dry up saving $1B a year. In this instance the duty increase will reduce revenue as it is to stop imports. The idea was that it will go a long way in reducing the balance of payments deficit.
We expect a 2012 balance of payments deficit of US$10B on trade, where imports will be US$20B and Exports US$10B. Remittances will plug this by US$6B and tourism by US$1B meaning the balance has to be borrowed or financed by some magicians touch. If things do not go according to plan, like the drought, it will cause an increase in Fuel imports to produce energy, it will increase our deficit despite the drop in oil prices.
If for some reason the IMF does not assist Sri Lanka because the country does not follow their strictures, then in the instance of a shortage, and in a floating exchange rate scenario, the country having hawked all its gold reserves to protect the rupee at unrealistic levels, will see a sudden and drastic fall of the rupee, to perhaps between Rs170 and Rs200 per US$1.
This will take place when confidence in the government’s ability to manage the economy is at a low ebb. The stock market is likely to be about 10% lower than currently. This is the time when due to problems in the banking system and financial companies, money will be tight. So people desperate for cash will try and reduce their stock portfolios, if they are able to get a better price.
At that time, there will be concerted effort by foreign funds, most likely from around the region, which will see value as a result of the in US$ terms 50% reduction in the value of shares, to pounce and buy up some of our companies on the CSE. If they are unable to buy, they will at least purchase up to the level which will trigger a bid. At this time the flood of money from overseas, will drive both the market and the exchange rate up giving the original overseas investors during that run up, a huge capital gain allowing them to remit their funds back. Sri Lankans will follow the herd, and buy these shares once they have risen, sold by the overseas investors, and be left holding another set of overvalued shares to be disappointed again if they are short term investors.
This was similar to what happened to the Asian economies. There was a time they contracted. We will see that time too, and perhaps by the end of the year, our GNP per capita in US$ terms would have fallen from US$2,800 at the end of 2011 to US$2,000 by the end of 2012 due to the exchange rate prevailing at that time. I challenge that this scenario is inevitable and desirable to clear the warts off the system. There are too many bad decisions made on the economy due to these incorrect assumptions, like the desire insane desire for a high $ GNP per capita.
There are two factors that can improve our situation. That is a reduction in the US$ price of oil and therefore fuel imports, and an increase in the remittances from the projected US$6B. The outlook on the agricultural side looks bleak, so exports of rice today could turn into imports in 6 months! The drought affects Tea Production immediately too.
The political stability that we appear to have on paper will also become an illusion once it dawns on the people that they have been taxed to the gunnels. The recent drop in the world market price of sugar resulted in an immediate increase by Rs10/kg this week in the tax on a sugar imports. Taxes on other items are more likely to increase than decrease making the cost of living an issue as it cannot be matched by increases in wages from an increasingly cash strapped government and also the private sector which now feels the pinch in the slowdown in the economy.
The hotel sector wonders why rooms are empty despite apparent increase in tourism! Why wonder when the reality is they are all being squeezed.
To sum up we must learn from people who have more insight than we do. The international funds pulled out of the Sri Lanka stock market with good profits, when our exchange rate was strong and markets were buoyant. They will return again when the exchange rate is weak and the markets down, to make another killing at the expense of the fools at the CB and Treasury, who seem to mismanage our economy, and still find fault with the foreigners for making profits!! What sour grapes.