Highest inflation in Asia!
View(s):It was just a few days ago that Ruwan submitted his price quotation to his client for a “paint work” that he got from a company. When he went there in the evening, the quotation had been approved. He was happy to receive the approved quotation for painting a company building.
Ruwan is a self-employed “service provider” in many technical fields such as painting, renovating, tiling, carpentry and even repairing electrical appliances. His income was irregular, but so far, he didn’t have an issue with that because his average income was better than from any regular employment.
As the economic crisis deepens in the country, however, it is a whole different story now; it is not easy to find work in Colombo, thus his average income has gone down significantly. Along with the lack of work and income, the shortage of basic needs and services have messed up the household life of average urban people much more than those living in rural areas.
Vegetable prices are soaring.
It was in this background that Ruwan got this paint job at least for a couple of weeks. As he decided to start the job without any delay, the next morning he went to buy paints. Alas he was surprised to learn that the price of a four-litre paint tin had gone up by Rs. 1,500 overnight.
Angered, he asked: “What? It was only yesterday that I got the prices from you and submitted the quotation to the company. How is it possible that this morning paint prices have gone up like this?” The shop keeper replied with a short answer: “Yes, but the government increased the prices last night.”
Ruwan could not resist his angry reaction: “So you got this stock of paints last night after that!” He didn’t receive a response to that, perhaps, because it may be a question to avoid.
Double punch
In an economic crisis like this, market uncertainties fueled by the choice of ad hoc economic policies, open opportunities to make quick bucks. In addition to the foreign exchange crisis and the debt crisis, Sri Lanka is faced with inflation – in fact, to be precise, stagflation!
The term “stagflation” is a combination of two words stagnation and inflation. The first term, stagnation depicts that the economy is in a stationary state without moving forward. In a situation as such economic activities get subdued so that people lose work and income. It’s a situation that many people like Ruwan are faced with. At a broader level of analysis, we would see a slowdown in economic growth and increase in unemployment and poverty.
The second term is inflation – continuous increase in average prices. Since October 2021, the average rate of inflation in Sri Lanka has increased beyond the upper margin of the inflationary target zone of the Central Bank, which is 6 per cent. It increased to 7.6 per cent in October, 9.9 per cent in November, 12.1 per cent in December, 14.2 per cent in January 2022 and 15.1 in February. The price increases in the food category have been much higher; the rate of food inflation reached double-digit level in mid-2021, exceeded 20 per cent in December and 25 per cent in February.
Thus, stagflation is a double punch on average people’s living standards. They lose income and work on the one hand due to “stagnation” and face rising prices on the other hand due to “inflation”. Why did the Sri Lankan economy come to this “stagflation” problem today? As we review the underlying factors carefully, it is clear that our own internal issues combined with global developments at the same time have been at the heart of the stagflation problem.
Man-made factors
Among the internal problems, the number one issue which had multiple repercussions on the economy was the massive money-printing. It was intended to meet the expenditure requirements of the government which faced the economic fallout of the COVID-19 pandemic in 2020, and its own political decision to cut taxes in 2019.
It is well-known in economic phenomenon that “prices begin to respond after a time lag” to such policies as money-printing, which we experienced since the latter half of 2021. Apart from that, money-printing also exerted pressure on exchange rate depreciation, due to the link between money and the external finance position. This made it necessary to adopt gradually-tightening import controls and foreign exchange restrictions, which also had multiple repercussions on economic affairs.
Import controls and foreign exchange restrictions led to supply shortages in the local market affecting both consumption and production. As both exports and domestic production felt the input shortages, local production and transportation got affected not only by the pandemic, but also by input shortages.
On the production-side, another blow was the fertiliser policy issue which lowered both the domestic and plantation agriculture production and productivity. It has contributed to both a decline in export incomes as well as domestic food supply. After all, exchange rate depreciation which did not slow down added another dimension to the increase in domestic prices of imports.
Global factors
As the global economic recovery was underway, world inflation was on the rise too. All major economies in the world, including the US, the EU, the UK and even Japan begin to experience increasing prices. By February 2022, within 12 months the rate of inflation rose to unprecedented levels from 2.6 per cent to 7.9 per cent in the US and, from 1.3 per cent to 5.9 per cent in the Euro area.
In particular, oil prices, food prices and the prices of industrial raw materials reported rapid upward trends affecting consumption, production and distribution in both advanced countries and developing countries. In spite of import controls and foreign exchange restrictions, Sri Lanka virtually failed to reduce its import expenditure so that the heat of the global inflation was felt in the domestic economy as well.
The problem has now been aggravated by the Russian – Ukraine conflict, which has far reaching consequences on both global production and global inflation. Apparently, the world economic recovery that began in the mid-2021 has now been curtailed significantly by the disruptions to production, trade, distribution and financial flows as well as economic sanctions imposed by Western countries.
Russia and Ukraine are major suppliers of oil, gas, coal, wheat, and other cereals to the world market. As a result of the war, energy prices are on the rise affecting manufactured production and transportation. Food prices are on the rise, not only due to the war-related disruptions, but also due to energy price hikes.
Austerity measures
In fact, Sri Lanka’s current inflation rate is the highest in Asia. It reveals that the internal factors underlying its current inflation are much more significant than the global factors. Having faced with multiple economic issues, the country’s vulnerability to inflationary tendencies appears to be greater than ever before.
The main issue in question is the way out not only from the clutches of severe inflationary tendencies, but also from the economic stagnation, supply shortages, debt crisis, and foreign exchange crisis. The most important question to ask is what were the specific policy measures that Sri Lanka implemented over the past two years?
As we continue to delay in responding to the emerging crises, the country is now approaching a time where the “way out” requires severe austerity measures – harsh policy measures to reduce public spending, increase taxes and curtail money growth. Austerity policy measures could be painful from an economic point of view and even costlier from a political point of view.
(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).
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