Sri Lanka is defined as a small open economy; it does not have the ability to alter world prices, interest rates or incomes. It is a price taker. Any attempt to change this reality by policy makers will manifest itself in economic imbalances which shall prove costly. However, whether they have reconciled themselves to this is a moot point.
The Black Ace
The imminent concern for Sri Lanka’s policy makers is; how to deal with the threat to its economy posed by the proposed bill for sanctions on the Society for Worldwide Interbank Financial Telecommunication -SWIFT- and its owners by the United States Treasury on their failure to exclude Iran's central bank, and other financial institutions from the system used to make payments between banks globally. SWIFT responded by saying that it complies with all sanctions and will continue to do so.
The implications for Sri Lanka are clear. The absolute reliance of the Sapugaskanda oil refinery on Iranian oil; and, the inability to reconfigure it to process oils from other sources before this bill becomes law will have grim consequences for Sri Lanka’s energy security. Suffice to say that unless Sri Lanka secures an exemption from this law, it will be compelled to import expensive distillates from foreign suppliers. Whether it can secure sufficient quantities to sate its demand is uncertain.
Iran is also the second biggest market for Sri Lanka’s tea exports. Sanctions will shut this market down.
The resultant effect on Sri Lanka’s already deteriorating balance of payments situation will be dire.
It is the US which holds the Ace on this and it will be played not by its Treasury, but by the State Department to further its policy objectives in Sri Lanka. All stakeholders know this; including other western countries, the opposition, Tamil National Alliance, civil society groups, the Diaspora and human rights organisations. And, there should be no doubt that every party who has a vested will have made representations on how it ought to be played through the US Embassy in Colombo and various other channels to the State Department.
On this issue alone Sri Lanka’s policy makers confront manifold challenges not just on the economy but also in other spectra.
The Red Ace
The GSP+ trade concession granted by the European Union benefitted 1.24 billion Euros worth of exports, mainly apparel, in 2008. The withdrawal of it inflated the cost of these exports by an average of 6.3 percent. Fourteen other countries which compete with Sri Lanka in the same markets enjoy this concession.
Apparel exports to the EU have increased by approximately 25 percent in 2011 to the end of November; although, fourth quarter volumes will be flat to 2010. Despite assertions to the contrary, it is difficult to argue that; if the GSP+ concession had been retained, export volumes would not have been higher, and, thus alleviate some pressure on Sri Lanka’s balance of payments.
Sri Lankan policy makers emphasise higher exports to the EU as evidence of the loss of GSP+ having no impact. Economists maintain that the tenure of outstanding contracts and; the necessary condition, that the cost of shifting production out of Sri Lanka must exceed the benefit derived from such a move, with the loss of GSP+ being one consideration, as reasons on why it will take time to effect. And, of course, new orders accruing at a slower rate.
Sri Lanka still remains the beneficiary of the GSP trade concession along with 176 countries and territories. But, withdrawing this concession is not without precedent as in the cases of Myanmar and Belarus for violations of International Labour Organisation (ILO) conventions. Such an action will shut out Sri Lanka from its largest export market. Allegations of violating ILO conventions have been levelled at Sri Lanka and they need to be credibly addressed if it wishes to avoid scrutiny by the EU. Scrutiny, leave alone suspension, can have severe adverse consequences on Foreign Direct Investment and new orders.
High Stakes Poker
Sri Lanka’s policy makers are engaged in a high stakes game of “heads-up” poker with their largest trading partners; who wish to see what the international community deems to be a credible inquiry into alleged war crimes and crimes against humanity perpetrated during its civil war. And, they will seek to pressure Sri Lanka’s weak points including its deteriorating balance of payments and vulnerability to external economic shocks; but without alienating its general populace, with the Aces they have been dealt. Sri Lanka’s policy makers can only hope for an improbable lucky draw to “bust” these Aces, or, play a game brinkmanship, which they have done very well for the past three years. However, by now, it is likely that their adversaries have very good “reads” on their play.
The writer was formerly a Director at Barclays Capital, the UKs largest investment bank and French bank Societe Generale. He has extensive experience trading corporate and sovereign bonds and credit derivatives. He also holds a PhD and Masters in economics from the University of Glasgow.