Terms of Trade of Sri Lanka

by R.M.B Senanayake

Our terms of trade, which refer to the prices fetched for our exports relative to the prices of our imports in the international markets, affects our standard of living. For a long time, we had favorable terms of terms and the prices of our imports were increasing relatively less rapidly than the prices for our exports. This provided a bonus to us in the sense that we were able to buy the same or even a greater quantity of imported goods for the same volume of exports. This is particularly important in the context that it has been difficult to increase the quantity of our domestically produced export supplies since we have more or less reached the limit of our resources that can be devoted to production by way of land, and labor. We no longer have a surplus of unutilized land which could be brought into use to increase production and can no longer expand the production area of primary products like tea, rubber and coconut.  We can only expand by improving productivity.

The increase in domestic consumption due to the increase in population and the increase in the living conditions of the poor has also led to greater domestic consumption. So nearly all the coconuts we produce are absorbed by domestic consumers. We used to export fresh coconuts to Pakistan.  Incidentally, should we ban the sale of adulterated coconut oil? Since coconut oil supply is short we must give priority to exporting it and earning foreign exchange. We should encourage the use of alternative cooking oils like palm oil for domestic consumption as we could thereby earn more by way of net foreign exchange. Of course it is not permissible to sell palm oil or any other vegetable oil as coconut oil. But should we not encourage the use of alternative vegetable oils for domestic consumption provided they are clearly marketed as such? This will enable us to export our coconut oil which fetches a good price in foreign exchange and use the cheaper imported cooking oil for our domestic consumption.  

For several decades even in the present century we had favorable terms of trade which gave us a bonus in our living conditions. But there are times when the terms of trade turn against us and generally during such periods we have had deficits in the current account of our balance of payments. Hence we have a real need to attract foreign investment to help our balance of payments.

During World War II years we accumulated large foreign exchange reserves because it was difficult to import goods due to enemy attacks at sea. But after Independence our rulers went on a spending spree and thereby exhausted our foreign exchange reserves.

Our present Foreign Exchange Reserve is barely sufficient. It is important for any trading country to maintain an adequate Foreign Exchange Reserve. What is adequate is defined by economists in terms of several months import requirements. But some of our post Independence governments were oblivious to this need and allowed imports freely to win popular support. Extra demand was created by running excessive budget deficits funded through money creation. Attempts to develop domestic substitutes to cut down on imports have been bedeviled by the fact that our domestic costs of production were higher than world production costs.

The failure to keep our domestic costs in line with world costs was due to excessive deficit budgeting, funded by money creation which made domestic inflation higher than the world inflation rate.  This meant excessive imports outstripping the growth in exports. But our politicians couldn’t care less. They were in power for five years and had only a limited vision and target. So they made no move to develop domestic production taking cover under the so-called free market economy. But the free market must take into account and be subject to economic fundamentals. Our politicians neglected to develop domestic production misusing the free market ideology.

Our present level of foreign exchange reserves is barely adequate and we need to rebuild them. We need to curb our imports to the level of our exports so that we can build a reserve in foreign exchange which is necessary to tide over a world economic recession. The world economy is subject to ups and downs and we should have sufficient reserves to weather downturns in the world economy which would reduce our export earnings in value terms. So we need to reduce imports. We cannot be lotus-eaters meditating the whole time to attain nirvana or the benefits of the other world. We have to live first and to live we need to consume and to consume we need to produce. We can obtain our needs by exchange but exchange requires that we produce and supply domestically goods needed by the outside world and exchange them for what we need.

We may be high cost terms in producing every good required by the world market. But we still need to exchange our domestic products to obtain foreign goods. The money illusion tends to blind people to this underlying requirement. Exports must pay for imports. But it is difficult to increase domestic production for exports. So we have to limit our desire for imported goods if we cannot produce exports to pay for them. We are today in an unusual situation which permits us to ignore this fundamental necessity because of the large volume of foreign currency remittances sent by our countrymen who labor abroad. But is it prudent to depend on it for the foreseeable future, since these countries ability to import depend on their surplus foreign currency earnings from oil. But economics has always demonstrated that where there are unusual profits possible, there will be alternative sources discovered or developed to take advantage of the surplus profits accruing only to a few suppliers. But these discoveries or inventions of alternatives may take time and are often fortuitous. So the need to limit imports to the capacity to pay for them through exports exists.  

 But the argument is really against the use of direct controls on imports such as the imposition of outright bans or limiting the imports through licenses limiting them to the aggregate value of licenses rather than to the limiting of imports itself.   Economists stress the need for controls of such imports through the use of market incentives and market forces. Since the quantum of imports is sensitive to the value of the exchange rate vis-a-vis the foreign currency expended, the usual way to reduce imports is through the resort to depreciation of the exchange rate so that more domestic currency is required to purchase the same value of foreign currency.

But our policy makers failed to realize that depreciation of the rupee does not work unless the Aggregate Demand is limited to the Aggregate Supply which required the absence of budget deficits funded by money creation (borrowing from the banking system instead of from the people). In short, depreciation of the currency does not achieve its intended favorable results unless deficit budgeting funded from money creation is also eliminated.  Therefore depreciation of the exchange rate works only where deficit budgeting funded by money creation is ruled out. But our successive governments, unless they are under IMF control, do not observe this necessary condition of elimination of deficit budgets funded through money creation instead of from borrowings from the savings of the people.

Today the government is under IMF control because we have borrowed from the IMF to tide over a balance of payments crisis. But if and when we regain independence for the government to exercise monetary policy it must learn and practice the lessons of prudent economics and finance. But do our politicians understand this? Not really for when elections come round they promise a plethora of benefits but without a word about how they propose to fund such promised benefits. They fool the public and sadly our people seem not to notice that they are being fooled. Our politicians have never asked the people to produce and export more if they want to consume more imported goods. We need to tell our people that there is no free lunch although the government at one time gave free rice. Fortunately good sense prevailed among the politicians and the issue was dropped in political campaigning.

We need to produce more if we want to import more. True we are presently able to meet the gap between imports and exports through the remittances received from our workers working abroad. But we need to save such foreign exchange for future use rather than bust the resource now. We could invest such savings in foreign exchange generating investments or in foreign exchange saving domestic products even subsidizing our domestic producers rather than busting such funds on consumption of more imported goods. We could use these resources to promote domestic export production instead of import promotion.

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