Exploding expenses and easing the economy

By the Economist

An unexpected encounter with Ranbanda as he was going into town focussed my mind on the mounting cost of living that is being discussed much more than any other issue by the common man. The increasing prices of daily consumed goods, services and utilities are making the life of the ordinary man intolerable. Discontent is certainly mounting as the prices of bus fares, kerosene, gas and numerous articles of common consumption keep on increasing.

“It is impossible to live these days, look at the prices of bread, dhal, bus fares, gas, kerosene and electricity. It is really impossible.” Ranbanda remarked without any provocation on my part. I remained silent as he continued his unprovoked, uncharacteristic outburst. “This is all because our politicians are wasting money on luxurious cars, travelling all over the country in expensive bullet proof vehicles or helicopters. And when they travel so many helicopters or cars are travelling with them. And they are travelling all over the world. They don’t care for us at all, we who have to travel by bus or walk.”

I felt I should add to the discussion by giving some sort of explanation for the rising prices as he must be considering me a part of the establishment responsible for these price hikes. “Ranbanda, I understand your feelings.” I said to appease him, “You can’t help this because we are fighting a war and it costs a lot of money. And then prices of petrol and gas are international prices over which we have no control.” He came back even more emphatically: “What nonsense sir, we could have won the war long ago. It’s all because of the corruption of the people in power. They like the war to go on as they are making big money. Haven’t you read in the papers how they are buying expensive equipment at twice and thrice the price in the market?” I thought I had had my lesson in economics for the day when he continued saying, “they say we have no money, then why do we have such a huge cabinet and spend money on so many cabinet ministers, their salaries, rented houses, large number of vehicles and their travel around the world.” I was silenced. His parting remark mingled with his bohoma isthuthi gihin ennang, “These politicians are spending our money, getting us into debt and increasing the prices of our daily expenses.”

I had heard a lesson in economics, not in the jargon of the professionals, but in simple ways of expression that illustrated the principles well. What was Ranbanda saying? In a nut shell he was telling me that it was the heavy public expenditure that was causing the price increase; that there was a tremendous wastage of public money and there was no response by politicians to the rising import costs. In the words of economists there was no fiscal discipline.

In this context official explanations are of little interest to the ordinary man. Predictions that there would be a deceleration of prices hardly sound authentic. The Central Bank assessment of the inflationary situation: “The growth in the Colombo Consumers’ Price Index (CCPI) for April 2007, dropped to 16.3 per cent on a point to point basis, from 19.5 per cent recorded in March 2007.” Coinciding as it did with further increases in the prices of petrol, gas, flour, milk and bread made it obsolete and irrelevant to the public. The news release went on to say: “The monthly decline was 0.1 per cent, continuing the declining trend for the third consecutive month for the year. This decline is in line with the forecast published in the Central Bank policy document “Road Map: Monetary and Financial Sector Policies”. In so far as May is concerned, it is most unlikely that the continuing tight monetary policy stance would have an impact on inflation. The improvements in the supply of produce during the peak harvest time that contributed to some prices declining in April are also unlikely to have a decreasing impact in the coming months. Hardly anyone would be convinced by the Central Bank prediction that the “Continuation of tight monetary policy stance will cause the inflation to decline continuously to a low rate of around 8.5 per cent by the end of the year on a point to point basis.”

There are several causes for the rising trend in prices. These include the rise in international prices particularly of oil and related products, the massive escalation of war expenditure particularly the huge costs of hardware imports, the increasing public expenditure on unproductive current expenditure (as illustrated by Ranbanda), the large trade deficit that is causing a strain on the balance of payments and consequently leading to a depreciation of the rupee. This in turn means that import prices rise in rupee terms.

For quite some time economists outside of official positions have been warning that inflation would continue to rise because of excessive money printing to finance the budget deficit. Fiscal discipline that reins in expenditure and increases revenue to reduce the budget deficit has been argued as a priority in economic polices. Though some lip service is paid to this contention, especially at the time of presenting the budget, there is scarce concern for limiting public expenditure. Wasteful and unproductive expenditure continues to fuel prices. Owing to this even when oil prices declined, the country’s rate of inflation rose.

Public expenditure is also one of the key reasons why the balance of payments is strained. The massive expenditure on the war is hurting the economy and is today the most significant factor in causing the high rate of inflation. In the context of this massive war expenditure, the expectation is that the government would take measures to curtail other expenditure. This has not happened. In fact as Ranbanda correctly observed the reverse is what we see. In this context tight monetary policy can only assist in a marginal way. Besides, tight monetary policy is inimical to economic growth in the long run. The long run however is hardly the concern of our politicians.