The Sunday Times Economic Analysis

The Sunday Times Economic Analysis By the Economist

Suppressing inflation only temporary sugar-coat
By the Economist
We are experiencing a period of repressed inflation. Though consumer prices are rising there are very significant items whose prices are kept in check owing to state intervention in the market. This is especially so owing to the government policy of not passing the increased costs of oil to the consumer.

The retention of petroleum product prices at previous levels means that a number of other items of consumption also are stabilised. The price of petroleum products have an important bearing on a number of other prices, most notably the price of electricity, as most of today's electricity is from thermal generation. If electricity prices rise nearly all production costs would rise. The other important area that could be affected by the rise in oil prices is an increase in transport costs.

This in turn leads to higher prices for even domestically produced goods. As it is also the usual practice of merchants to increase the price of transport of goods much higher than the increase in their costs owing to an increase in oil prices, it means that the prices of a large number of items would rise sharply. Therefore any increase in oil prices would lead the way to an increase in the general level of prices. The initial increase in oil prices would lead to increases in prices of goods commonly consumed by people. These include rice, vegetables, fruits and many other items of food and other consumer items.

The current action of the government not to pass on the oil price increase to consumers will not allow this chain of events in prices to occur. However there is no way in which inflation could be averted ultimately. What happens is that the actions of the government would contain inflation for some time but have an inflationary impact later through a chain of other consequences. It is only a matter of time for the people at large to experience much higher price increases.

How does this happen? First of all the Petroleum Corporation as well as the Ceylon Electricity Board would suffer losses. These have to be made good by the Government. This could be done in several ways. The government could increase taxation. It could opt not to do this but instead incur a large budget deficit. In which case the government could opt to raise funds in the market or to resort to what is commonly known as "printing money".

By whichever way this is done it leads to an increase in prices and other adverse consequences. The Central Bank has projected a rise in prices of only 5 to 6 per cent this year. It is somewhat difficult to see how inflation could be kept to such a low level even with inflationary pressures suppressed in this manner. There are other inflationary trends in the economy. Already rice and domestically produced food items have increased in price. The depreciation of the Rupee will have an impact on imported prices. Even the average food consumption basket has about a 25 per cent of imported foods, such as wheat flour, bread, sugar milk and fish. These prices would rise. In turn they would result in other costs rising. The impact of the sharp deterioration in the value of the Rupee would be quite pervasive.

There is no doubt that much of the inflationary pressures are being created by either external factors over which the country has no control or internal factors such as weather. In addition the dislocation of economic activity owing to the elections would have also had its say. The possibility of countervailing factors to reduce inflation have also not been possible owing to the climate of economic uncertainty and lack of confidence in a government more involved with political power struggle issues.

It is also the political situation that has made the government adopt a policy of not passing on the additional costs of petroleum imports to the consumer. Electoral promises of reducing the cost of living, the instability of the government and provincial council elections have been the foremost considerations in this policy stance. What people must understand is that the suppressed inflation will build up pressures that would be unleashed in the fullness of time in many ways.

Meanwhile we can only hope that the turn of events internationally would reduce oil prices and make the impending inflation, balance of payment difficulties and the fiscal burden more manageable.

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