Financial Times

Restoring economic stability
Last week's Central Bank decision to raise its benchmark interest rates, after keeping them static for one year, marks a significant change in its monetary policy and is likely to be welcomed by those in the market who have been calling for a more realistic policy that would prevent the economy running off the rails.

Coming just a week before the government's maiden budget, the rate hike signifies the beginning of efforts to restore economic stability and will help curb inflation and ease pressure on the rupee.

The currency had depreciated sharply against the dollar and sterling this year as the government kept interest rates down despite the pressure on the exchange rate.

The rapid depreciation of the rupee in turn had other adverse repercussions - raising the costs of imports in our import dependent economy. Central Bank efforts to defend the rupee led to the depletion of foreign reserves.

While governments do build up reserves during good times to serve as a cushion when economic conditions turn difficult, the draw down of foreign reserves to defend the rupee was not at all healthy and could not be done indefinitely.

While some strong medicine is required to bring economic fundamentals back to normal levels, the government obviously has to do its best to cushion the impact on the poor of the worsening economic conditions and the adjustments that are necessary.

The government's policy till now of keeping interest rates low meant a raw deal for savers. They were, in effect, getting negative returns on their savings which were actually being used to subsidise the rich - while savers got negative returns rich corporate entities got access to cheap funds.

The government has very few choices in the situation it is in. On one hand it has had to cope with the entirely unexpected increase in oil prices. On the other it has to face a much lower inflow of foreign resources as aid funds that were pledged with much fanfare by donors are not coming in. This is because the aid was clearly tied to progress in the peace talks and this progress has been stalled by the LTTE's intransigence.

The Tiger terrorists, in all probability, are stalling the peace process to achieve precisely this effect - to make things difficult for the government so that its bargaining position at the negotiating table gets weaker and weaker, making it more amenable to pressure from the LTTE and its foreign backers to cave in to the LTTE's demands.

Add to this the loss of popularity on the domestic front. The forthcoming budget predictably will impose more taxes on the rich in order to raise the money to fund the government's generous election pledges and welfare measures for the poor.

To be fair by the government, its economic planning would have gone haywire because of the unprecedented increase in crude oil prices which have an across-the-board effect on the economy, increasing prices and fuelling inflation which directly hit the consumer.The cash-strapped government's anticipated measures to raise desperately needed revenue has predictably drawn flak from the private sector. However, it is likely to welcome some of the other proposals that are believed to be in the budget that have a 'development thrust'.

These trade and tariff proposals are designed to create a level playing field for local industrialists, generate more employment and curb the inflation which makes our producers less competitive.

However, some of the proposed revenue raising measures appear impractical - such as identifying those who own cars and mobile phones in an effort to draw them into the tax net - especially in a nation where dodging taxes has been elevated to almost an art form.

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