Global recovery and early warning
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File picture of the Colombo Port which is gradually recovering after the COVID-19 pandemic.
The global economy is on the road to recovery. It is being supported by the progressive COVID-19 vaccination programme as well. It could be a point to rejoice for many countries, but not for everybody. I thought of getting this point across today as an early warning. Some of the countries with weaker economic structures which had an “easier time” with the global economic recession would have new challenges with the global recovery.
Even though the subject area is a bit heavy, it is important for us to know where we are heading now. At least to a great extent, the economic uncertainty is fading away. The basic elements of the current policy regime of Sri Lanka too get obsolete creating new challenges.
Recovery path
As per IMF growth projections, the world GDP which contracted by 3.5 per cent last year will expand by 5.5 per cent this year. It is a very high rate of growth for the world economy after 45 years. However, it is not unusual to have such a high growth after a deep contraction of GDP so that a large part of the high growth reflects restoration back to normalcy.
The high growth of the world economy will be contributed by similar higher growth numbers of the advanced countries which will have a higher rate of GDP growth of 4.3 per cent. The US, the Euro area, the UK and Japan, all four economies which contribute to about half of the world GDP, will also have a higher growth this year. The two economic giants in Asia – China and India, will also experience a massive GDP growth at 8.1 per cent in the former and 11.5 per cent in the latter. The US and China, the first and the second largest economies in the world, make up over 40 per cent of world GDP so their contribution to the world recovery is very important.
Consequently, unless there are unforeseen adverse events and circumstances again in the global economic atmosphere, the next couple of years will be a path to recovery of the world economy. Along the path to recovery, there will be some other developments too. One of the major developments would be the inflationary pressure building up at a global scale.
Commodity prices
Already there are signs of commodity price hikes in the world economy. The oil prices which plummeted even below US$20 a barrel in the middle of 2020 have been on the rise; already it has increased to over $60 a barrel. As the growth recovery is underway, its demand pressure on oil is due to push up the long-term world prices. While the fast-growing big economies will demand more oil, its price hikes are always accompanied by the increase in widespread global commodity prices.
World food prices are on the rise too. The global food price index of the UN’s Food and Agriculture Organisation (FAO) which remained below 100 over the past five years, has been rising since mid-2020 and reached 116 in the last month of the year.
There is nothing unusual about the closer movement of commodity prices and economic growth along the business cycles of the world. As the world economy plummeted during the past few decades, the inflation trend was also on the downward path. When the world economy is picking up now, within the next couple of years the world inflation is bound to move up again.
Along with an upward trend in world inflation, there is another important macro variable which would make its return to the forefront – interest rate. So far, the world economy has been experiencing the downward trend in long-term interest rates. Even though we may not see it immediately, within the next couple of years the interest rates too would rise.
It is the usual business cycle trend that both the inflation rate and the interest rate move closely in the same direction with economic expansion and contraction, unless we are taking about a specific case of a “stagflation”.
Policies against crisis
In Sri Lanka too there were policies against a crisis of the economy as elsewhere. But we had a worse economic situation than elsewhere because our economic crisis was not limited to the COVID-19 pandemic issue. Before that we had to bear adverse economic repercussions of the Easter Sunday terror attack, but that’s not all. Even before that, the Sri Lanka economy did not show signs of picking up after the end of the war, but that’s not all either. Since the turn of the century, the economy had already reflected worsening growth potentials that had been discussed repeatedly.
After all, however, inevitably the set of policies were of a crisis-ridden economy: The government had to increase spending against worsening revenue growth. Thus, it was financed by the Central Bank; by the end of 2019 the Central Bank held about Rs. 75 billion worth government securities, which had grown to over Rs. 800 billion by now – that is lending to government. Apart from that, the Central Bank increased money to the commercial banks which also increased their lending to the government to finance government spending.
Some of us then call it as Keynesian policies because the government is attempting to mitigate the adverse economic repercussions of the loss of private spending. Some may see it as the revival of the ideas of modern money theory, because they see that the Central Bank is financing government spending.
Policy tags
The above policies of a crisis-ridden economy would not have been possible if there was inflationary pressure which had naturally subdued in the economic recession. Inflation rises during economic expansion and falls during recession. Therefore, with economic recovery we should see inflationary pressure mounting again within the next couple of years.
This means that the years ahead with economic recovery are not a period for further fiscal and monetary policy stimuli. Rather in terms of both monetary expansion and government spending, it will be a period for minding inflationary pressure due to an unwarranted increase in demand. Then it requires a gradual move towards monetary discipline and fiscal consolidation.
Monetary discipline leads to reverse Central Bank’s financing of government spending. Fiscal consolidation leads to raise tax revenue and curtail spending, limiting the budget deficits. Now some of us will come to label it as Monetarist policies, because the Central Bank is cutting down excess money growth. Some may even call it as the revival of neo-liberal policies because the government is withdrawing by making more room for the private sector. In this case, the alternative policies are more about the needs of the time than the choices with labels.
By the way, the period of economic recovery is also characterised by an upward pressure on interest rates. In fact, higher interest rate is a tool too for containing the unwarranted demand and arresting inflationary pressure.
Prepared for recovery
Countries can prepare for the recovery rather than waiting for it to come from out of the blues; this is exactly what we meant by the “opportunities in crises”. Earlier we mentioned about an “unwarranted increase in demand” as feeding into inflationary pressure. It is unwarranted, because the potential GDP growth remains subdued due to lack of reforms.
This is the key issue for Sri Lanka, because there has been no purposive policy reform process in the country after 1989 reforms. But there have been many policy changes of an ad hoc and piecemeal nature, including sporadic policy reversals. The economic crisis would have been an ideal situation with opportunities to make corrections in the country’s structural issues limiting its growth momentum.
What would happen, if we are not prepared for the recovery by exploiting the opportunities? Well, we will soon enter into our mediocre growth path that we had been experiencing in the past prior to the COVID-19 pandemic issue.
(The writer is a Professor of Economics at the University of Colombo and can be reached at
sirimal@econ.cmb.ac.lk and follow on Twitter @SirimalAshoka).