People tighten their belts but pressure on rupee continues

There is a report in today's Sunday Times that local bakery owners have noticed a decline in sales following increases in the price of bread.

I happened to have a chat with a banker on Friday and he said much the same thing. Based on volumes of imports channelled through this particular bank he said that they had noticed about a 15% decline in wheat imports, a 20%-25% decline in milk powder imports and perhaps a further 10%-15% in other supermarket food and FMCG items.

People are indeed tightening their belts therefore the pressure on the currency should ease. This has not because of Government expenditure and construction projects.

The US$500m raised by the Bank of Ceylon was borrowed by the Government and used to settle creditors, possibly including some petroleum bills. No one has a clear idea of what it was used for but bankers seem to think that the money was spent within a couple of weeks.

The infrastructure projects including the Mattala Airport and Hambantota port as well as private sector construction projects contribute to the growth in imports which rose 17% in the quarter to March 2012.

The problem with construction projects is that once started they are difficult to stop.

Infrastructure and construction are not bad things in themselves. They contribute positively to the calculation of the GDP number, which is, in simple terms, a measure of output. They can also create a lot of genuine activity in the local economy, depending on the amount of local content in the project.

The problem is that with the Chinese projects, local content is small, so the process of construction provides minimal boost to the local economy, despite the fact that they do in fact flatter the GDP calculation. Materials, equipment and even labour comes from China.

This is partly why the country reports high GDP growth number while many people fail to see an improvement in their standard of living. Money comes in and goes out, barely touching the local economy. If local labour, local contractors or local suppliers were used, jobs would be created and local businesses would benefit.

The bigger issue is the viability of the projects themselves. A Chinese funded and built project is still good, provided it serves the purpose and most importantly generates an adequate return that covers the cost of finance. The project needs to be able to service the debt used to build it at a minimum. If it fails to do so, then there is a big problem, as the Spanish are now slowly waking up to.

The morning after a particularly hard party can be painful.
  


A little more on the positive side of labour in  Chinese projects is here. There is a good debate in the comments section.