Why the trade deficit widened despite import restrictions and export growth | Print edition

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Despite severe restrictions on non-essential imports, shortages of essential imported items and export growth of 27%, the trade deficit widened in 2021 due to the sharp increase in import spending. This rather paradoxical result was due to the structure and composition of imports and exports.

Trade deficit

The trade deficit has increased to a record $4.6 billion in 2021 despite severe import restrictions and an increase in exports.

Despite restrictions on imports of non-essential imports and difficulties in obtaining foreign exchange for imports, import expenditure increased from US$16 billion in 2020 to US$20.6 billion in 2021. This increase imports of 28.5% or US$4.6 billion was due to increases in consumer goods, intermediate goods and capital goods.

This implies that a large part of our imports are essential and difficult to contain.

The 2021 trade deficit was the highest in three years. Import growth of 21% offset strong export growth of 28.5%. Last year’s exports of $15.6 billion were the highest export earnings in the past three years. Yet the trade deficit widened due to rising imports.

Puzzle

What baffles most economic watchers is how the trade deficit soared amid tight import controls, foreign exchange restrictions and impressive export growth. The answer lies in the structure and composition of the country’s imports and exports.

Import dependency

The country has been a major export economy for centuries. This has been especially true in the modern era. During the first three decades after independence, the country’s exports consisted mainly of primary products, tea, rubber and coconuts and there was a heavy dependence on all categories of imports : foodstuffs, durable consumer goods, raw materials and capital goods.

Change

Although the country’s import and export structure changed after the economy was liberalized in 1977, the economy continues to be dependent on imports. However, the character of import dependency has changed.

Industrial exports

Exports of manufactured goods accounted for about 75% of the country’s exports, compared to less than 25% of agricultural exports. While the domestic value added of agricultural exports is about two-thirds, the value added of manufactured goods exports is only about 40%. This explains why an increase in exports to 15 billion US dollars did not make much noise in our trade balance.

Raw materials

Intermediate imports consisting of raw materials for industry, fuel and other essential products for industry and people’s livelihoods are an important component of imports. In addition, imports of essential foods and other items were high.

Persistent trade deficits

It is this export-import character that has led to persistent trade deficits. There have only been four years of small trade surplus between 1950 and 2021.

Consequences

The implications of this analysis are that the trade deficit can only be reduced through much higher export growth, including growth in agricultural exports which have not held up well due to insufficient exportable surpluses.

A strategy of restricting imports is impractical because most imports are essential for people’s livelihoods, raw materials for industry and agricultural production.

Essential imports

This reliance on essential imports means that international price increases have a huge impact on the country’s import spending. This is particularly the case with respect to fuel import expenditures which increased last year. Fuel imports increased by $1.2 billion to $5 billion, or 20% of total import expenditure.

Other significant increases in import spending were for textiles and textile articles, machinery and equipment, base metals, medical and pharmaceutical products, chemicals and plastics. There were also increases in telecommunications devices, household appliances, food and beverages. These are essential for the economic production and livelihoods of the country.

Recapitulation

Despite import restrictions and currency shortages, imports grew by 28.5% or $4.6 billion to reach $20.6 billion in 2021. This is the highest level of last three years.

The exception was fertilizer imports which fell 39 percent to $158 million with disastrous consequences for the economy. Consequently, agricultural exports are expected to decrease and food imports to increase this year.

Conclusion

The Sri Lankan economy will remain an import-dependent economy due to the country’s limited resource base. As last year’s trade results demonstrated, import controls are not a solution. Much higher exports of goods and services are needed to contain the trade deficit to an amount that will be offset by workers’ remittances, tourism revenues and net capital inflows.

Trade and exchange rate policies are key to improving foreign trade and payments performance. Broader economic reforms are necessary for a lasting resolution of the country’s economic difficulties.

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