Crises in Japan, Middle East, West Africa will not hinder global
recovery - Dr. Saman Kelegama
In a globally integrated economy any
socio-economic, political issue or natural disaster creates ripples of
consequences on each and every economy, be it big or small.
Dr. Saman Kelegama
Political crises in the Middle East and West
African countries and the triple disaster in Japan have created panic
about the future of the global economy. Executive Director and Fellow,
Institute of Policy Studies of Sri Lanka, Dr. Saman Kelegama in an
exclusive interview with ‘Sunday Observer’ did an in-depth analysis on
the impacts of these issues on the Sri Lankan economy.
Q: Two global events, the triple disaster in Japan and the
political crisis in the Middle East are posing a threat to the global
economy. What is the direct impact of these crises on the Sri Lankan
A: These are two different events and not inter-related, so we
need to separate them to identify the impact.
Both events have created global uncertainty in regard to oil prices,
behaviour of the Yen, capital flows, etc. Moreover, the impact of these
two events on the above mentioned variables is amplified by increased
speculative activities normally associated with uncertainty.
In regard to oil prices, there will be an escalation due to the
crisis in the Middle East and North Africa, but oil prices will not
escalate as it did in 2008 to levels above US$ 140.
Most experts are of the view that the average oil price in 2011 will
increase to about US$ 105 due to the current crisis, although it has
peaked to US$120 a barrel in international trading (Brent Crude oil
What is important to note is that other than Libya, all other crisis
ridden countries in North Africa (Egypt and Tunisia) and Middle East
(Bahrain and Yemen) are not oil exporters.
Moreover, Libya accounts only for a small proportion of international
oil production. It accounted for 1.5 million barrels a day (MBD)
compared to 2.4 MBD of Iraq, 2.5 MBD of Kuwait, 2.8 MBD of UAE, 4.1 MBD
of Iran, and 10.1 MBD of Saudi Arabia (data for 2009).
Thus, disruption in oil production in Libya is not going to have a
major impact on international oil supplies but speculative forces are
working on a possible spread of the crisis to the major oil producing
countries like Saudi Arabia and Iran.
Sri Lanka’s oil import bill was approximately US$ 3 billion in 2010
out of a total import bill of approximately US$ 13 billion
(approximately 23 percent of imports).
On the other hand, our export earnings in 2010 were close to US$ 8
billion and remittances amounted to US$ 4 billion. With all other
capital inflows (FDI, borrowings, portfolio capital, etc.), Sri Lanka
will record a balance of payment surplus in 2010. Thus, absorbing the
crude oil price increase in 2011 will not be a major problem.
There are reasons to believe that our export earnings in 2011 will
improve with the increasing ready-made garment exports (Sri Lanka seems
to have gained from the crisis in Egypt, strikes and work stoppages in
Bangladesh, and escalating cost of production in China), and increasing
When oil prices go up, the price of synthetic rubber also goes up and
as a result the demand for natural rubber goes up.
Although rubber prices dropped due to the events in Japan as
speculation grew that demand for rubber from the motor vehicle industry
in Japan will decline, in the medium-term the “oil price effect” on
rubber will be stronger than the “Japan crisis” effect.
The increasing tea prices (again the relatively high prices were
disturbed by the Egyptian crisis, but with normalcy returning to Egypt,
good prices should prevail).
There will not be a major disruption in remittances as the key
destinations for Sri Lankan migrants (Saudi Arabia, Kuwait, UAE and
Qatar) have not been affected by the crisis.
There are concerns on the escalating import bill.
Tokyo, JAPAN : Foreign currency
traders call orders under a sign posting the foreign
exchange rate between the US dollar and the yen, as well as
share prices at a foreign exchange market in Tokyo on March
17. The Japanese yen continued to surge in early Asian
trade, hitting a new record high of 76.52 yen against the US
dollar since World War II following Japan’s disastrous
earthquake and tsunami. AFP
The Ceylon Petroleum Corporation’s losses in 2009 was close to 0.5
percent of GDP and its monthly losses are close to Rs. 2 b. With
international oil prices gradually increasing, the government will find
it extremely difficult to absorb these price increases either in the
form of a subsidy or by removing duty (tariffs) applicable to oil
imports, and there may come a situation where a part of the price
increase may have to be passed on to the consumer.
Oil imports are influenced by many factors. When rain declines, Sri
Lanka’s dependence on oil for electric power generation increases but
with the rains that we received in January/February, the hydro power
generation was at its peak and there was no need for excessive oil
dependence for power generation.
However, car sales increased. During January to October 2010 motor
vehicle imports have increased to 285,000 compared to 164,000 during the
corresponding period in 2009.
This in turn means that after the global economic recovery in 2010
and as a result of tariff reduction for motor vehicles in June 2011, the
demand for motor vehicles has gone up and with it the demand for oil.
These are areas where we have to keep a close watch in the context of
the escalating oil import bill.
The Japanese crisis will also not have a significant impact on Sri
Lanka. Japan is not a major export market for Sri Lanka, accounting only
for two percent of total exports from Sri Lanka.
Most Japanese imports such as electronic goods and motor vehicles are
produced and supplied to Sri Lanka from other countries, so in regard to
trading there may not be a major problem.
However, as Japan will focus more on reconstruction and
rehabilitation, there will be less emphasis on bilateral aid. Japan has
been the largest donor for Sri Lanka for many years and Japan will find
it difficult to maintain this position in the coming years.
Q: What is the significance of Japan in the global economy and
how will it affect the other economies?
A: Japan is the third largest economy in the world after the
USA and China (both in nominal GDP and purchasing power parity).
Japan’s main trading partners are USA and China.
Nineteen percent of Japanese exports and 23 percent of Japanese
imports are for/from China, and 17 percent of Japanese exports and 11
percent of Japanese imports are for/from USA.
The Tokyo stock exchange is the second largest in the world by market
capitalisation. Japan has a large industrial base and is home to some of
the largest and technologically advanced motor vehicles, electronics,
machine tools, etc.
Japan is home to 326 companies from the Forbes Global 2006.
In the global foreign exchange market, the Japanese Yen is the third
most traded currency after the US dollar and the Euro. Low interest
rates since the mid-1990s combined with ready liquidity for the Yen have
prompted investors to borrow money in Japan and invest in other
currencies. This is known as ‘Carry Trade’.
Thus Japan’s public debt per GDP is about 220 percent - the largest
ratio among industrial countries. Given this strength and peculiarities
and the inter-linkages with the global economy, obviously any major
event in Japan is bound to have an effect on most other economies. The
impact will vary depending on the links with the Japanese economy.
Q: Appreciation of Yen is a major concern and leading Central
Banks have launched a coordinated intervention to stabilise the Yen. How
does the Yen appreciate and what are the impacts of it on the global
A: The Yen appreciation gathered momentum just before the
global economic crisis.
Yen appreciation is due to many factors. First, Japan has a huge
balance of payment surplus.
Second, heightened concerns on the US economic outlook have triggered
capital outflow from US, Europe, and emerging economies to the Yen,
which is regarded as a relatively safe asset. Moreover, Japan’s
financial system has been less hurt than the US and EU.
Why did the Yen appreciate soon after the disaster when we expected
the opposite effect? This was due to: (a) As we all know, Japanese are
big purchasers of foreign securities.
They have bought many foreign assets: American, European and Asian
bonds. Japan is one of the world’s biggest net creditors with US$ 3
trillion of net overseas assets.
The crisis in Japan has caused some investors to sell foreign assets
and bring back money to Japan.
This creates additional demand for Yen and pushes its value up, and
(b) expectations that Japanese insurers and companies will bring money
home to pay for claims and reconstruction.
A strong Yen is an impediment to the export-driven economy of Japan
and contributes to further deflation of the Japanese economy which in
any case is growing very slowly.
The G-7 decided to intervene in the currency markets to slow the
appreciation of the Yen.
The concern is that further appreciation would hamper Japan’s
recovery effort by making Japanese exports less competitive.
The intervention in the currency market by G-7 has been welcomed by
the Japanese Finance Minister, Yashiko Noda.
After the intervention, the US dollar amounted to 81.48 Yen compared
to the value of 76.25 Yen on March 17.
On the implication of an appreciated Yen on the global economy: Yen
appreciation has created a new structure that has consolidated into the
Japanese economy and reduced the manoeuverability of policy variables in
the Japanese economy.
This structure has to be gradually weakened.
What is this structure ? I referred to ‘carry trade’ earlier.
Now a basic description of the Yen carry trade is that traders borrow
Yen in Japan at low interest rates, convert the Yen into another
currency, and invest the funds at a higher interest rate.
The trader then earns the interest rate spread between the two
currencies, but bears the risk that the Yen will appreciate before the
loan is repaid.
It is not easy to measure the total size of the Yen carry trade, but
it is massive. This fact highlights the concern of what will happen if
the Bank of Japan raises interest rates significantly. The Bank of Japan
has been threatening to raise rates for years, but has not done so.
Why ? If the Bank of Japan raises interest rates it could undermine
the cheap leverage that has been available for so many years.
The unravelling of these trades could no doubt have a major impact on
global financial markets. International financial markets have evolved
into a single global economy and it is important to watch the Bank of
Q: How does it affect Sri Lanka, our debt payments and trade?
A: Japan is the largest lending country in the world. Japan accounts for
more than 25 percent of bilateral claims on developing countries.
A large part of Japanese exposure (approximately 60 percent) is in
In some Asian countries, more than 25 percent of their long-term debt
is Yen denominated (in Thailand it is close to 50 percent).
In Sri Lanka, Yen denominated debt is about 26 percent compared to 19
percent of US dollar debt and 8 percent of Euro debt. Thus, Yen
appreciation vis-a-vis the US dollar is bound to have an effect on the
debt situation in Asian countries like Sri Lanka.
In Sri Lanka, public debt per GDP is above 80 percent and as per the
agreement with the IMF we have to bring this ratio to about 65 percent
in the next 2-3 years.
In this context, an appreciated Yen will be of concern because
Yen-based debt payments will escalate.
I think the end of deflation in Japan has been brought forward by
this disaster. Japan will get out of the ‘liquidity trap’ and its
domestic demand will increase.
Although not a large export market, this will mean that Sri Lankan
exports to Japan will have more demand in the future.
One can say so because after the Kobe earthquake (which hit a large
city unlike the present tsunami), the economy shrunk in the quarter
following the disaster but large scale rebuilding saw a boost to the GDP
in the following quarter.
Since the Yen is kept at a level just above 80 per US$ with G-7
intervention it will be good for Asian countries like Sri Lanka which
has more than a quarter of its debt denominated in Yen. A weaker Yen
will reduce the debt servicing burden for Sri Lanka.
Q: Will all these issues reduce global economic growth further
reversing the recovery?
A: Not necessarily, because Japan coming out of deflation is
good for the rest of the world.
The tsunami devastation is in a sense an opportunity in disguise for
Japan to rise out fast from the calamity.
The Middle East and North African crisis will not have a major impact
on oil prices as explained earlier. Although there is much uncertainty
from both these events, they cannot make major inroads to reverse the
global economic recovery.
Q: Two factors are posing pressure on oil prices, possible
supply disruption due to Middle East political tension and possible
demand increase after the nuclear plant tragedy in Japan. Will this lead
to another oil shock?
A: There is now speculation that the demand for oil will
increase, as developed nations may have concerns on expanding nuclear
But this maybe a temporary phenomenon. There was similar speculation
after the Chernobyl disaster in 1986 but once the radiation levels
subsided, it was business as usual. Nuclear plants have expanded with
The demand for oil will increase due to the cut down on nuclear
energy is premature.
Also to say that there will be a major disruption in oil supply due
to the North Africa and Middle East crisis, may also not be accurate.
The winter season is over in Western countries and their economic
recovery is slow.
Thus the demand for oil will not see an exceptional increase.
The growth of India and China along with the rest of Asia is
generating a high demand for oil but this phenomenon was there before
the twin crises in Japan and the Middle East. Thus, I do not foresee
another major oil shock.