In the three year period 2005-07 US purchased about 28% of Sri Lanka’s merchandise exports and EU 35% accounting annually for a total of about $4.4 billion in export earnings. Even a modest 5% drop in this amount would cause Sri Lanka a loss of $219m which is roughly equal to the total education budget in 2008.

In recent year about 40% of the tourists to Sri Lank have come from Western Europe. In hard times one of the first casualties in the family budget is the vacation abroad.

The drop in oil prices has provided some relief to the Sri Lankan economy. But the oil exporting countries in the Middle East that employ large numbers of Sri Lankans are also suffering. Thus less Sri Lankans will be employed in those countries and the foreign exchange that the country earns and the incomes that the families in Sri Lanka get will suffer.

Thus our exports, employment and foreign exchange earnings will suffer this year from the global recession.

In the period January-September 2008 Sri Lanka attracted more foreign direct investment (FDI) than in the comparable period for 2007. But starting the last quarter of 2008 global FDI flows to developing countries have shrunk and we have less reason to be optimistic about FDI this year.

Given the above situation, the nation’s economy faces two major short term challenges. One is how to maintain output and the jobs that we have and create more growth and more jobs for the unemployed. The second is how to keep importing oil, medicine and other essentials and also avoid drastic foreign exchange control such as restrictions on foreign travel and foreign education.

The 1970s “solution” was severe import restrictions and foreign exchange control. That is not a viable option unless the Rajapakse administration wants to turn the clock back.

Until the global economy improves our exporters may have to cut prices to protect market share. That has limits because they usually work on thin profit margins and it is not easy to bring down the cost of production. The government could give exporters a subsidy so that they could sell at a lower price. But government resources are limited. Moreover, such subsidies can be in violation of international trade law.

In theory the loss of demand for our products abroad can be substituted with local demand. This is what, for example, USA and China have done with large stimulus pages and budget deficit. But our government and our economy does not have that option. We cannot drink more tea or buy more clothes that we stitch merely because foreigners now buy less. If the government tries to stimulate local demand with a large budget deficit either inflation will increase or imports will increase.

Neither is it very practical to think of giving alternate employment, in the short-term, to tens of thousands of people who lose jobs in export industries such as garment.

For a variety of reasons substantial donor grant aid is also not a good prospect in the near term. The only option left is borrowing money from abroad. Borrowing from commercial sources as the Rajapakse administration did in the last two years will be difficult. Following the sharp drop in the country’s foreign reserves from about $4.5 billion at the end of September 2008 to around half that amount by the end of the year our sovereign credit rating outlook was revised downwards to “negative” outlook. This makes commercial borrowing more difficult and more expensive. So the government has resorted to the last option available and requested a loan of $1,900 million from the IMF.

The government says that it would not accept the IMF loan if conditions are attached. But a condition-free loan is most unlikely. IMF will insist on a depreciation of the rupee, pressure the government to eliminate fiscal waste such as Mihin Air, and undertake structural reforms such as the reorganization of the CEB.

A loan from the IMF will help moderate the impact of the recession on our economy. But just as much as many countries including the USA are using the crisis as an opportunity to restructure their economies Sri Lanka should make a serious bid to do the same to reduce our dependence on garments and a few primary exports.