Home
Login to reply
SrirangaVeteran
- Posts : 3226
Join date : 2014-02-23
Location : Colombo 
The economic choice before the new government
Sat Aug 22, 2015 9:50 pm
By R.M.B Senanayake
The election results show that the people are learning the importance of national policies without depending only on populist politics. The SLFP has generally promoted populist politics over economic realities. The UNP, more aware of national economic interests and how economic growth should be promoted, has not generally espoused populist politics. But they too have found it necessary to resort to such measures to win power. This is the only country in the world which gave free rice funded by borrowings and even bank borrowings which is the modern equivalent of printing money. They even talked of economic development funded by printing money instead of from savings as advocated by economists. Fortunately the country was blessed with foreign aid, a good part of which was free of interest and the rest at concessional terms. But that era seems to be over.
Now economic realities cannot be ignored
The previous government funded its investments partly from loans obtained from China; nothing wrong with that as long as we are able to repay such loans as they fall due. Of course these should be economic transactions and not linked to any foreign policy considerations. The criticism of the previous government’s development policy is that it did just that and sought to mortgage the country to the Chinese by over-borrowing from them. They also did not disclose the details of such project based borrowings to the public. All foreign agreements should be tabled before Parliament but this apparently had not been done. The new government should correct this lapse. The public have a right to know about the borrowings of the State and such disclosure was an established practice previously.
Government borrowing should take into consideration not only the benefits of a project but also the benefits in relation to the costs and whether the terms of borrowing are cheap and affordable by the country. The long term interests of the economy have to be considered and this includes not only the economic but also the foreign policy considerations. We cannot afford to antagonize India and have to stick to our tried and tested policy of non-alignment.
The choice before the new government
The new government has a choice. It can carry on as usual pushing only for economic growth ignoring the effects it could have on the current account of the balance of payments. We have been running deficits in the current account of the balance of payments almost from 1978. We were able to do so only because we received foreign capital inflows which offset these current account deficits. Some of it was in the form of foreign aid. But now that we are a middle income country we are not entitled to concessional foreign aid and are expected to borrow from the international capital market for our development needs. Such borrowings have to be weighed carefully for we should be able to earn extra foreign exchange to repay the higher interest as well as the foreign debt principal.
The economy seems to be slowing down now and the first quarter growth rate is reported to be 6% whereas previously we had seven and 7.5% growth rates. But equally if not more important is to ascertain what are the sources of growth. The previous government promoted growth through public sector investment but they did not raise adequate revenue to fund such investments. Instead they resorted to extensive borrowing and borrowed much from China. We could borrow from the international capital market but foreign investors will consider our foreign debt repayment capacity when they consider our demand for foreign borrowing in foreign exchange.
Foreign versus domestic borrowing
There is however no such risk of default in the case of borrowing domestically in rupees since the government can always create rupees to repay such debt. But it is not so with regard to foreign borrowing. We need foreign exchange to repay foreign currency borrowings. We can obtain foreign exchange by earning it through higher exports while holding down imports. But foreign exchange is obtained also from foreign investment in the country as when a foreign party sets up a local industry or buys shares or subscribes to government bonds. We have been running deficits in both the Trade Balance (the difference between imports and exports of goods) as well as in the Current Account of the balance of payments which includes income or expenditure from services and unilateral transfers from our migrant workers abroad. The remittances received from our migrant workers abroad have come to our rescue. But these remittances also cannot increase forever. So there is a risk in excessive foreign borrowing. What constitutes excessive is difficult to define but it primarily depends on our export earnings relative to imports including the remittances received from our nationals working abroad.
Foreign exchange needed for development
We need both domestic rupees as well as foreign currency to fund our development expenditure since we have to import capital goods like machinery and equipment and intermediate goods like raw materials required for development. Most development projects require imported capital goods such as machinery. In addition to what is required for development we also depend on the import of agricultural products for consumption; then we must import oil, fertilizers and so on. Incidentally the fertilizer subsidy should be done away with since it is providing an incentive to the overuse of a scarce resource paid for by an even more scarce resource - foreign exchange.
How will the government find the foreign exchange for development expenditure?
Since we depend on the government to spearhead development it is necessary for the government to raise the required financial resources before it can spend them. Any government is in a unique position since it can create rupees to fund its expenditure though not foreign exchange. But there are adverse consequences where the government creates too much domestic money- rupees. The people who receive the money expended or doled out by the government spend it on goods and services. These include a large component of imported goods and services. But the imported goods and services have to be paid for in foreign currency which the government cannot create. So it has to also borrow foreign currency. Our total external debt as a percentage of the GDP is 57.4%. Since the GDP for 2014 is $9,545 million and the external debt is $5,478.83 million, our over-all debt service ratio is 20.2% of exports, which is about the prudent limit judging from the performance of certain Latin American countries in the previous debt defaulting crisis of the 1980s.
We have been running current account deficits for many years and no government has hitherto taken action to reduce it. The day of reckoning may be distant. But a current account deficit reflects an excess of expenditure over income. It can be sustained only by running down the Foreign Exchange Reserve of the country unless it is counteracted by foreign capital inflows in the form of foreign aid or private capital inflows. In the past we received a considerable amount of foreign aid. But now we have to depend more on private foreign capital inflows as foreign aid has dried up. It is not therefore prudent to depend entirely on foreign capital inflows from the rest of the world since the global economy is subject to cyclical and other fluctuations.
The importance of the Current Account
A current account deficit in the balance of payments reflects an excess of expenditure over income, in this case income in foreign exchange. To correct a deficit in the current account not offset by capital inflows, the foreign expenditure must be cut or receipts from foreigners must be increased. So the state of the current account in the balance of payments is important in considering how much more we can keep on borrowing. Latin American countries which over-borrowed in the 1980s had to default on their debts. Recently Greece is finding that it is not in a position to repay foreign debt although most of it is to the European Union of which it is a member.
Since a current account deficit in the balance of payments reflects an excess of expenditure over income, to correct a deficit expenditure must be cut or receipts must be increased. Governments which seek to correct an excessive deficit resort to direct controls like import and exchange controls but these are economically inefficient. In the past we too have resorted to a plethora of controls and suffered a reduction in the growth rate of the economy. But it is also not possible to ignore a persistent deficit in the current account of the balance of payments. It is certainly risky to be so dependant as the Latin American countries found out in the 1980s and Greece does today. The creditors sooner or later realize when the country is over-borrowed and runs the risk of debt default. It is then that they try to put a stopper on their foreign lending and soon other countries follow suit.
Borrowing from the international agencies is then the only alternative. But the IMF, the World Bank and other foreign lending institutions also look at the country’s incapacity to repay debt and may diagnose it as the result of faulty expenditure policies of the government. They will insist on controls on government expenditure before they lend to such a country.
www.island.lk
The election results show that the people are learning the importance of national policies without depending only on populist politics. The SLFP has generally promoted populist politics over economic realities. The UNP, more aware of national economic interests and how economic growth should be promoted, has not generally espoused populist politics. But they too have found it necessary to resort to such measures to win power. This is the only country in the world which gave free rice funded by borrowings and even bank borrowings which is the modern equivalent of printing money. They even talked of economic development funded by printing money instead of from savings as advocated by economists. Fortunately the country was blessed with foreign aid, a good part of which was free of interest and the rest at concessional terms. But that era seems to be over.
Now economic realities cannot be ignored
The previous government funded its investments partly from loans obtained from China; nothing wrong with that as long as we are able to repay such loans as they fall due. Of course these should be economic transactions and not linked to any foreign policy considerations. The criticism of the previous government’s development policy is that it did just that and sought to mortgage the country to the Chinese by over-borrowing from them. They also did not disclose the details of such project based borrowings to the public. All foreign agreements should be tabled before Parliament but this apparently had not been done. The new government should correct this lapse. The public have a right to know about the borrowings of the State and such disclosure was an established practice previously.
Government borrowing should take into consideration not only the benefits of a project but also the benefits in relation to the costs and whether the terms of borrowing are cheap and affordable by the country. The long term interests of the economy have to be considered and this includes not only the economic but also the foreign policy considerations. We cannot afford to antagonize India and have to stick to our tried and tested policy of non-alignment.
The choice before the new government
The new government has a choice. It can carry on as usual pushing only for economic growth ignoring the effects it could have on the current account of the balance of payments. We have been running deficits in the current account of the balance of payments almost from 1978. We were able to do so only because we received foreign capital inflows which offset these current account deficits. Some of it was in the form of foreign aid. But now that we are a middle income country we are not entitled to concessional foreign aid and are expected to borrow from the international capital market for our development needs. Such borrowings have to be weighed carefully for we should be able to earn extra foreign exchange to repay the higher interest as well as the foreign debt principal.
The economy seems to be slowing down now and the first quarter growth rate is reported to be 6% whereas previously we had seven and 7.5% growth rates. But equally if not more important is to ascertain what are the sources of growth. The previous government promoted growth through public sector investment but they did not raise adequate revenue to fund such investments. Instead they resorted to extensive borrowing and borrowed much from China. We could borrow from the international capital market but foreign investors will consider our foreign debt repayment capacity when they consider our demand for foreign borrowing in foreign exchange.
Foreign versus domestic borrowing
There is however no such risk of default in the case of borrowing domestically in rupees since the government can always create rupees to repay such debt. But it is not so with regard to foreign borrowing. We need foreign exchange to repay foreign currency borrowings. We can obtain foreign exchange by earning it through higher exports while holding down imports. But foreign exchange is obtained also from foreign investment in the country as when a foreign party sets up a local industry or buys shares or subscribes to government bonds. We have been running deficits in both the Trade Balance (the difference between imports and exports of goods) as well as in the Current Account of the balance of payments which includes income or expenditure from services and unilateral transfers from our migrant workers abroad. The remittances received from our migrant workers abroad have come to our rescue. But these remittances also cannot increase forever. So there is a risk in excessive foreign borrowing. What constitutes excessive is difficult to define but it primarily depends on our export earnings relative to imports including the remittances received from our nationals working abroad.
Foreign exchange needed for development
We need both domestic rupees as well as foreign currency to fund our development expenditure since we have to import capital goods like machinery and equipment and intermediate goods like raw materials required for development. Most development projects require imported capital goods such as machinery. In addition to what is required for development we also depend on the import of agricultural products for consumption; then we must import oil, fertilizers and so on. Incidentally the fertilizer subsidy should be done away with since it is providing an incentive to the overuse of a scarce resource paid for by an even more scarce resource - foreign exchange.
How will the government find the foreign exchange for development expenditure?
Since we depend on the government to spearhead development it is necessary for the government to raise the required financial resources before it can spend them. Any government is in a unique position since it can create rupees to fund its expenditure though not foreign exchange. But there are adverse consequences where the government creates too much domestic money- rupees. The people who receive the money expended or doled out by the government spend it on goods and services. These include a large component of imported goods and services. But the imported goods and services have to be paid for in foreign currency which the government cannot create. So it has to also borrow foreign currency. Our total external debt as a percentage of the GDP is 57.4%. Since the GDP for 2014 is $9,545 million and the external debt is $5,478.83 million, our over-all debt service ratio is 20.2% of exports, which is about the prudent limit judging from the performance of certain Latin American countries in the previous debt defaulting crisis of the 1980s.
We have been running current account deficits for many years and no government has hitherto taken action to reduce it. The day of reckoning may be distant. But a current account deficit reflects an excess of expenditure over income. It can be sustained only by running down the Foreign Exchange Reserve of the country unless it is counteracted by foreign capital inflows in the form of foreign aid or private capital inflows. In the past we received a considerable amount of foreign aid. But now we have to depend more on private foreign capital inflows as foreign aid has dried up. It is not therefore prudent to depend entirely on foreign capital inflows from the rest of the world since the global economy is subject to cyclical and other fluctuations.
The importance of the Current Account
A current account deficit in the balance of payments reflects an excess of expenditure over income, in this case income in foreign exchange. To correct a deficit in the current account not offset by capital inflows, the foreign expenditure must be cut or receipts from foreigners must be increased. So the state of the current account in the balance of payments is important in considering how much more we can keep on borrowing. Latin American countries which over-borrowed in the 1980s had to default on their debts. Recently Greece is finding that it is not in a position to repay foreign debt although most of it is to the European Union of which it is a member.
Since a current account deficit in the balance of payments reflects an excess of expenditure over income, to correct a deficit expenditure must be cut or receipts must be increased. Governments which seek to correct an excessive deficit resort to direct controls like import and exchange controls but these are economically inefficient. In the past we too have resorted to a plethora of controls and suffered a reduction in the growth rate of the economy. But it is also not possible to ignore a persistent deficit in the current account of the balance of payments. It is certainly risky to be so dependant as the Latin American countries found out in the 1980s and Greece does today. The creditors sooner or later realize when the country is over-borrowed and runs the risk of debt default. It is then that they try to put a stopper on their foreign lending and soon other countries follow suit.
Borrowing from the international agencies is then the only alternative. But the IMF, the World Bank and other foreign lending institutions also look at the country’s incapacity to repay debt and may diagnose it as the result of faulty expenditure policies of the government. They will insist on controls on government expenditure before they lend to such a country.
www.island.lk
Permissions in this forum:
You cannot reply to topics in this forum