Central Bank accountable for inflation

Inflation levels have reached 21.6 percent according to the new Colombo Consumer Price Index, the CCPI(N). It has reached 24 percent based on the old index, the CCPI, making the inflation in Sri Lanka the highest in the region. According to the lead economist at Lirneasia, Dr. Harsha De Silva, the Central Bank (CB) is accountable for these high levels because inflation is a purely monetary phenomenon which is fuelled by an increase in money supply.

Speaking at a seminar organized by the Ceylon National Chamber of Industries (CNCI) this past week, De Silva said inflation has adversely affected the export industries such as garments and in addition to the company level problems, it is also creating demand level problems in terms of the decreasing disposable incomes. Businesses are facing several severe problems such as increasing interest rates, making it difficult to plan for the future.

CNCI Chairman, A.K. Ratnarajah said that inflation is 'rampant' in spite of the efforts of the CB and other authorities to control it. He said the problem of inflation has affected everyone including businesses and individuals and requires solutions on how to deal with it.

De Silva questioned if some officials at the CB were confused as to the correct definition of inflation. According to a presentation made by the CB on February 14, the definition of inflation was the 'sustained increased in rate of increase in price level.' However, De Silva said the correct definition of inflation is the 'sustained increase in the general price level' and therefore, the CB definition is inconsistent with theory.

He also said the introduction of the CCPI(N) and changing the basket of goods was a good thing except the suppression of certain items such as the removal of alcohol and tobacco. Furthermore, the sample changed from the working class to include everyone and the weighting given to food in the CCPI(N) is far lower than in the CCPI, being 46.7 percent as opposed to 68.3 percent. He said this serves to underestimate the inflation of the poor. Even in the United States, there is a separate index called the CPI-W, the urban wage earners and clerical staff, which comprises of 13 percent of their population. De Silva said that an index such as that should be introduced in Sri Lanka as well.

De Silva said that inflation is not a necessary evil and that monetary policy cannot sustain a lower level of unemployment beyond the natural level at higher inflation. In fact, he said it is inconsistent with economic theory. It is true that some prices increase due to outside factor and influence such as the increase in world prices but that there are no other countries that have such high inflation.

Since the creation of the CB in 1950 two years after independence, the average inflation level in Sri Lanka was 7.4 percent up until 2004. Commenting on the CB's Monetary Policy Road Map for 2007, De Silva said the public was told that inflation would start to decline by mid-April 2007 and that the inflation forecast for 2007 was a minimum of 6 percent and a maximum of 11 percent. He said the actual inflation levels were 300 percent more than the minimum forecast and 120 percent more than the maximum forecast. According to De Silva, the CB was way off its targets due to an economic problem, not an accounting problem.