Sri Lanka's balance of trade has been in a chronic state of deficit since 1957 the only year between 1957 and 1987 when there was a surplus was 1977 (see table 10, Appendix A). Although the ability to pay for imports has generally declined because ÍÍÍÍof the long-term relative fall in the prices of tea, rubber, and coconut, the demand for imports has been fueled by population growth and rising expectations. The resulting shortage of foreign exchange has been the greatest problem in the economy during the period since independence. For most of the 1960s and 1970s, the government imposed strict import and exchange controls in an attempt to control these deficits. After 1977 the deficits were allowed to grow and were financed by increased foreign support and heavy borrowing.

Few nations have experienced so drastic and long-term a deterioration in terms of trade as did Sri Lanka from the mid-1950s to the mid-1970s. As a result, the volume of imports fell, at first through severe restriction of luxury items, such as automobiles and spirits. But the structure of the economy limited the amount by which imports could be cut. Levels of food, medicines, spare parts, and fertilizer could not easily be reduced without damaging the economy or the population's welfare. The gap was met by borrowing, and debt service obligations further reduced import capacity. Although the volume of exports was nearly 18 percent more in 1975 than in 1960, the proceeds from these exports had a purchasing power worth only 37 percent of the smaller volume of exports in 1960.

Although the general trend in the terms of trade was against Sri Lanka between 1955 and 1988, there were occasional exceptions. The terms of trade showed a 35 percent improvement in 1976 over 1975, and 31 percent in 1977 over 1976, when tea prices experienced an unprecedented rise of 80 percent. From 1979 to 1982, however, the terms of trade again turned sharply against Sri Lanka, reaching record lows in 1981 and 1982. Between 1983 and 1987, the terms of trade hovered near the level for 1981, with the exception of 1984, when an increase in the price of tea produced a temporarily more favorable position.

After the liberalization of the economy in 1977, the trade deficit widened enormously as the import bill soared under the influence of the government's development program. Exports, however, remained largely static. The trade deficit thus expanded year by year and reached nearly Rs20.5 billion in 1982, equal to 22.4 percent of GDP. In 1983, as a result of good agricultural production, the deficit was held to the same level as in 1982. The following year, 1984, the deficit was cut to Rs10.2 billion as a result of exceptionally high tea prices. This gain was not sustained in 1985, when the trade deficit rose to Rs17.8 billion. In 1986, despite a static level of imports attributable primarily to the decline of world oil prices, the trade deficit again widened, to around Rs20.5 billion. Sharply reduced earnings from tea were only partly offset by improved exports of manufactured goods, 100 especiecially textiles. Preliminary figures for 1987 shÍÍÍÍowed a record trade deficit.

Sri Lanka's major export earnings were derived from a small number of commodities (see table 5, Appendix A). In 1986 textiles overtook tea for the first time as the leading export. Textile exports were worth around Rs9.6 billion, compared to under Rs9.3 billion for tea. Rubber exports, which have declined since the 1970s, were worth Rs2.6 billion in 1986. Coconut products accounted for Rs2.4 billion, fuel oil products for Rs2.3 billion, and gems for over Rs1.6 billion. Other exports, including agricultural produce, graphite, and manufactured goods, were valued at around Rs7.8 billion. This breakdown reflects a substantial diversification of exports away from tea and rubber in the 1970s and 1980s, but in early 1988 the fluctuations in the world prices of these commodities continued to be an important factor not only in the island's export earnings but in the health of the economy as a whole.

Oil accounted for about 25 percent of the value of imports in the early and mid-1980s, but dropped to 11.5 percent in 1986 when its price fell sharply and additional hydroelectric power became available from the Accelerated Mahaweli project. Some of the output of Sri Lanka's single oil refinery was then reexported. Other significant imports included machinery and equipment, chemicals, motor vehicles, clothing, paper, and sugar. Rice imports declined in the late 1970s and early 1980s by 1985 Sri Lanka was close to self-sufficiency in years with good weather. In 1986 rice accounted for only 1.9 percent of imports.

The United States was the most important foreign market, accounting in 1986 for approximately 26 percent of the island's exports, mostly in the form of textiles and tea. The Federal Republic of Germany (West Germany), Britain, and Japan also were important markets in the 1980s, although no single country other than the United States took more than 8 percent of exports in 1986. The leading source of imports was Japan, which accounted for over 17 percent in 1986. The United Arab Emirates, Saudi Arabia, the United States, Britain, China, and West Germany also were important sources of imports. In the 1960s and 1970s, about 50 percent of rubber exports went to China in return for rice on favorable terms, but after around 1980 Sri Lanka no longer needed to import large quantities of rice. Higher oil prices led to an increasing proportion of imports coming from the Middle East this was paid for in part with increased exports of tea to this region.

Although the island's balance of payments position was closely related to the balance of trade, foreign aid and remittances from Sri Lankans employed overseas made the balance of payments more favorable than the balance of trade. As a result, Sri Lanka occasionally ran a small balance of payments surplus in the 1960s and 1970s, and again in 1984, when the economy benefited from high tea prices. In 1986 Sri Lanka had a balance of payments deficit of US$406 million, down from US$556 million in 1985. The main factor was the trade deficit of US$750.2 million. Private transfers, mostly remittances, amounted to US$294.5 million, about half of which were from the Middle East. Official transfers, including aid from governments and international organizations, accounted for US$181.2 million. Sri Lanka's services account ran a deficit. Exports of services, including earnings from tourism, were US$378.1 million, while imports in this sector, including interest payments on foreign loans, amounted to US$509.6 million.

Data as of October 1988