The objective of this short article is to present key reasons why the CB Governor will miserably fail in stabilizing the economy and getting the inflation down to a single digit by the end of this year as he promises.

Background of inflation control by the CB/Central Banks

• The CB like many other central banks believe that inflation inflation is a monetary phenomenon as a result of excess money stock causing excess demand for goods and services beyond the supply.

• Therefore, the strait forward answer that central banks have is to keep the monetary policy tightened in order to decelerate the monetary growth which will then decelerate the demand. They believe that this will drive inflation towards the target used for the conduct of the monetary policy. The inflation target in Sri Lanka is 4%-6% YoY as compared to 2% in developed countries.

• The present monetary policy is based on targeting the inter-bank overnight interest rates through central bank policy interest rates. Policy interest rates are the interest rates used by central banks for their overnight deposit and lending operations with banks and other permitted securities dealers. The CB’s policy rates at present are the are standing deposit facility rate (SDFR) and the standing lending facility rate (SLFR) applied for overnight deposit and lending operations with commercial banks and primary dealers in government securities. 

• As central banks are prepared to lend and take deposits at these rates without any limits possible due to their money printing power, inter-bank overnight interest rates will remain within the policy interest rates corridor. Therefore, policy interest rates are a form of price controls in the overnight money market supported by money printing.

• Therefore, the key monetary policy decision taken by central banks from time to time is the determination of policy interest rates, i.e., hike or cut or hold at current level. In the case of hike or cut, by how much is the unjustified decision.

• Accordingly, in times of inflation rising continuously above the target, central banks keep hiking policy rates gradually until inflation is firmly back on the path to the target. At present, almost all central banks (except central banks in China and Japan) are on this game from the beginning of last year.

The CB’s rate hikes in the current cycle

The CB commenced hiking policy rates in mid-August 2021 well before inflation started rising above the target. Accordingly, present policy rates corridor is 14.5%-15.5% elevated from 4.5%-5.5% in mid-August 2021 after five rate hikes with a total of 10% so far whereas the behaviour of inflation is not justified with policy rates (see the table and two charts below).

The present CB Governor accelerated the rate hikes by a record 8% expecting to be a world hero of inflation control in a crisis-hit economy. As a result, all interest rates rose to sugar high levels followed by the rapid rise of government securities yield rates to 30%-33% (see the chart below), despite the significant magnitude of money printing used to suppress the yield rates.

Even a layman will understand the catastrophe that the economy will suffer at such high levels of interest rates at the time it is hit by a historic economic crisis.

How rate hikes are expected to bring down inflation

Rate hikes are expected to slower the demand for goods and services and thereby reduce inflation through five major channels.

• First, interest rates throughout the economy will rise fairly quickly. Inter-bank interest rates and government securities yields will rise immediately and other interest rates will follow suit shortly.

• Second, as the cost of borrowing and capital is now higher, consumption and investment financed by credit will decline because modern monetary economies run on credit. This is the first round of deceleration in demand. This will effect primarily through the private sector as the government spending generally does not respond to changes in interest rates.

• Third, the second round of deceleration in demand comes through the contraction of production activities and employment. The reduction in private consumption and investments will contract production activities which will raise unemployment of factors. As a result, factor incomes, i.e., wages, rent, interest and profit, will decline. The decline in factor income leads to deceleration in demand. This happens primarily in the informal sector of the economy.

• Fourth, hike in interest rates will reduce the value of financial assets and wealth which is a factor contributing to consumption and investment of the private sector. Therefore, the depressed value of wealth also will reduce the demand, primarily through reduced credit on lower value of wealth/assets under collateral and reduced capital gains. This is also another source of deceleration in demand.

• Fifth, higher interest rates are expected to attract foreign capital in economies with open capital account if interest rates rise faster than those in countries competing for foreign capital. The new inflow of foreign capital will appreciate the local currency. The currency appreciation will raise the foreign currency price of exports and reduce the local price of imports. As a result, net exports (exports less imports) is expected to decline (depending on export and import elasticities), causing a decline in the demand. This is another source of deceleration in demand. In addition, the reduction in local currency cost and prices of imports also will directly reduce domestic prices and inflation.

Accordingly, the deceleration or reduction in the demand for goods and services will bring the demand to a greater balance with the supply, given externally. As a result, the narrower gap between the demand and supply will reduce the general price level and inflation. This is known as the transmission of the monetary policy.

This is what the monetary theory predicts as to how inflation will come down in response to policy interest rates hikes.

However, macroeconomic outcomes in reality are different from the theory. Further, side effects in the event interest rates rise stubbornly high could be catastrophic depending on their impact on the public trust in banking and finance. For example, unduly high interest rates can even cause banking and financial crises through various sources.

Can Sri Lanka expect above channels of monetary policy transmission?

Those channels cannot be expected because current inflationary pressures in Sri Lanka are not demand-driven. High inflation is a result of depressed supply side and cost-push amid the global corona pandemic, collapse of the import sector due to the CB’s failure to maintain a foreign currency reserve for BOP purposes, excessive devaluation of the rupee by the CB (i.e., nearly 85% rise in the exchange rate), default of foreign debt, significant rise in globally energy prices and grave political and economic instability.

Therefore, policy interest rate even at 100% cannot resolve the supply side and cost push factor behind high inflationary pressures.

• First, high interest rates in fact will aggravate them through the increased cost of production and contraction of the economy via first three channels.

• Second, asset channel is very poor in Sri Lanka as compared to advanced market economies due to primitive capital market.

• Third, exchange rate channel is not available as the country is in default of foreign debt and exchange rate is administratively fixed at the over-value. Therefore, neither capital inflow nor currency appreciation can be expected even if interest rates are at 100%.

• Fourth, policy interest rates corridor is no more relevant for the policy transmission as the CB has imposed limits or rationing on its overnight standing deposit and lending operations with effect from 16 January 2023. As a result, money market volatility and manipulations seen at present have potentials of even hitting systemic risks in the current context.

• Fifth, the CB Governor has been running after the IMF for a loan of US$ 2.9 bn and debt restructuring for nearly one year so far. If he can stabilize the economy (greater balance between the demand and supply) and bring down inflation to a single digit by the end of this year through policy interest rates, the rationale for going after the IMF and debt restructuring, which are fiscal instruments, is questionable.

Fundamental problems in the monetary policy model

The present monetary policy model is implemented on unestablished concepts and bureaucratic discretion and, therefore, lacks the public accountability.

• The extent and duration of the policy transmission are not known and not empirically tested. Therefore, brave talks on transmission time of 12-18 months from each interest rate decision are just bluffs.

• The extent and frequency of changes in policy rates effected to hit the inflation target have no basis. Therefore, like in other central banks, the CB changes interest rates in different magnitudes at different intervals while sitting down and looking at inflation data.

• Rate decisions are taken by looking at the inflation rate estimated as the annual percentage change of the Consumer Price Index (CPI). This is only a statistical inflation rate driven by the base effect. Therefore, inflation tends to ease after some points even when the CPI and cost of living continue to rise or remain at elevated levels. The central banks boast on the prudence of monetary policy actions as soon as the disinflation begins due to the base effect, despite elevated price pressures broad-based across all sectors or markets of the economy.

• Interest rate is a key activity driver in modern monetary economies. It is a risk-based driver of distribution of productive resources and income. Therefore, policy interest rates and statistical inflation are unrelated variables to base the inflation targeting monetary policy. 

• Prices of goods and services and thereby inflation are a result of the interactions between commodity markets and factor markets. The inflation as defined in the monetary policy and economics is the change in the general price level due to imbalances between the demand for and supply of goods and services. Therefore, the use of CPI inflation and inflation analysis presented from price changes in the CPI basket is a flawed practice followed in monetary policy decisions.

• In modern open economies with electronic money and information technology, demand side and supply sides are inter-connected real time and, therefore, demand cannot be separated for the control of inflation as conceptualized in the monetary policy. In fact, supply chains inclusive of marketing drive the demand where both supply side and demand side are real time responsive to interest rates. In fact, it is the contraction of the supply side that has to reduce the demand in the second round in response to high interest rates. Therefore, the assumption of externally given supply side used in the monetary policy for the control of demand side through credit independently from the supply side is highly irrelevant and outdated.

• Although central banks state that interest rates/monetary policies get transmitted through interest rate sensitive demand sectors, they do not have any idea of what those sectors or impacts are. Instead, they analyze changes in the prices captured in the CPI to find out how inflation has changed. This is a highly unacceptable, micro analysis for a macroeconomic policy such as monetary policy.

• The CB’s claim that high interest rates are required to control imports through costly credit due to foreign reserve problem is baseless. Import control is a fiscal measure. The use of policy interest rates for such cross purposes violates the present monetary policy model whereas the CB has direct measures to control imports.

Concluding Remarks

Several public concerns can be raised as below on present monetary policies of central banks.

• The present model of central banks as independent monetary authorities is outdated as their operations reflect extreme communism as well as extreme capitalism. Central banks are highly communist organizations as monetary side of the economy is centrally planned by few central bank bureaucrats. They are highly capitalists as they expect the market mechanism to drive prices, redistribution of resources and growth in response to centrally planned interest rates and money printing. Therefore, such dubious organizations run by few individuals pose a threat to modern democracy and economic freedom.
• The present model of policy interest rates-based monetary policy is highly irrelevant for economies confronted with currency and debt crises as the market mechanism is not available to transmit the monetary policy across the demand side of the economy as expected in monetary textbooks. Therefore, Sri Lanka cannot expect any stabilization through the present monetary policy.

• Devastating impacts of policy mistakes on generations and unaccountability despite continuing policy mistakes cannot be tolerated. The present interest rate policy of the CB has pushed the crisis-hit economy to bankruptcy, but political leaders who do not understand such facts treat the CB Governor as the divine landed to save the country from the economic crisis.

• Inability to assess the policy performance and effectiveness in modern market economies is a serious flaw. Therefore, underlying monetary concepts are practiced in line with closed, tribal economies with primitive currency .

• Inconsistency of policy statements, rhetoric, media interviews and forecasts which are made based on policy complacency results in the loss of policy credibility.

• The policy is expected to stabilize the economy, i.e., getting the demand to a greater balance with the supply, in old macroeconomic management models and, therefore, the policy is highly irrelevant for modern economies. When this is questioned, central banks state that only the interest rate instrument is available for them to stabilize the economy. If so, central banks fall far below the expectations built in relevant public mandates.

Therefore, it is high time for professionals and political leaders to debate on the relevance and usefulness of the present monetary policy models to the general public and to effect a model refix, accordingly, rather than calling for full independence offered to central banks for the control of the monetary side of the general public as central bank bureaucrats wish.

Otherwise, it will not take a long time for the state central banks to be extinct and for governments to loose the control over the economy. It is in this context that a new school of modern monetary theory has emerged to advise the policymakers because central bank officials are neither rocket scientists nor divine creatures.

(This article is released in the interest of participating in the professional dialogue to find out solutions to present economic crisis confronted by the general public consequent to the global Corona pandemic, subsequent economic disruptions and shocks both local and global and policy failures.)

P Samarasiri

Former Deputy Governor, Central Bank of Sri Lanka

(Former Director of Bank Supervision, Assistant Governor, Secretary to the Monetary Board and Compliance Officer of the Central Bank, Former Chairman of the Sri Lanka Accounting and Auditing Standards Board and Credit Information Bureau, Former Chairman and Vice Chairman of the Institute of Bankers of Sri Lanka, Former Member of the Securities and Exchange Commission and Insurance Regulatory Commission and the Author of 10 Economics and Banking Books and a large number of articles publish. 

The author holds BA Hons in Economics from University of Colombo, MA in Economics from University of Kansas, USA, and international training exposures in economic management and financial system regulation)

Economy Forward: https://economyforward.blogspot.com/2023/02/why-cb-governor-will-fail-to-deliver-on.html

Entire Cabinet, NMRA, Health Services Director General, Bribery Commission Customs and two Indian companies named among 47 respondents.

Transparency International Sri Lanka (TISL) yesterday filed a fundamental rights petition (SC/FR 65/2023) in the Supreme Court naming 47 Respondents, in relation to the steps taken by the Cabinet of Ministers, Health Minister, the Ministry of Health, and the National Medicines Regulatory Authority (NMRA) to procure medical supplies from two Indian private companies.

TISL said this case was filed in the public interest, and challenges the following: The role of the Cabinet of Ministers in procuring medical supplies through unregistered private suppliers, the role of the NMRA in providing a Waiver of Registration to procure medical supplies from unregistered suppliers, non-compliance with procurement guidelines including the emergency procurement process and Abuse of process by the Health Minister and the NMRA Chief Executive Officer.

In its petition, TISL alleged that the citizens’ fundamental right to equality (Article 12(1)) and the right of access to information (Article 14A) have been violated, along with serious disregard for the health, safety and wellbeing of the people and in total abuse of public trust and public funds.

TISL seeks further information on these transactions.The petition seeks interim orders against: The procurement based on this unsolicited proposal and the placing of any orders, Approvals for Waiver of Registration of 38 drugs, Importation of said drugs into Sri Lanka and Making payment for such drugs

The Commission to Investigate Allegations of Bribery or Corruption, Customs Director-General, Inspector-General of Police, Savorite Pharmaceuticals, Kausikh Therapeutics (P) and the Attorney-General are also named as respondents in this petition.

Sri Lanka has already received more than 300 medicine items as of December through the Indian credit line and hopes to complete all orders by March 2023, officials said.

From the one billion US dollar credit line from India, 200 million USD was to purchase medical supplies, with the State Pharmaceutical Corporation (SPC) given the responsibility of placing the order.

Sri Lanka has seen medicine shortages since late June with the Central Medicine Storage running out of stocks.

The authorities said that, until stocks are restored, the ministry has implemented a central communication strategy to facilitate the exchange of medicines between medical institutes based on availability.

The SPC called tenders in March and, by April, the tenders were being evaluated by the officials.

“Of the 200 million US dollars we received, we allocated 55 million US dollars to the private sector supplier,” Chairman of SPC Sarath Liyanage said.

Orders will be placed for 674 medicine items and 17,88 surgical equipment, Liyanage said.

“So far we have received 74 medicine items through the SPC and more than 300 plus from the private sector supplier. No matter which sector you are bringing it from, the products’ origin must be India, which is a condition we have to follow.

“By December 31 2022, we have to place all the orders and we hope by March 2023, we will have received all the medicine and equipment we have ordered.”

The island nation is currently struggling with lack of medicine in the health sector and, due to high demand and the low supply, the prices have increased in pharmacies and people have reduced their prescribed dosage.

Officials said the Indian credit line is being utilized according to a particular procedure, which took the local authorities around a month to understand along with how the letters of credit will be issued to the Indian banks and how the orders must be placed

Ceylinco General Insurance and SLT-MOBITEL recently announced the launch of a unique insurance benefit offered to SLT-MOBITEL customers.

Under this new insurance cover, ‘Ceylinco SLT-Mobitel Ananthaya’, SLT-MOBITEL customers are entitled to a Serious Illness insurance of up to Rs 500,000 and a Personal Accident insurance of up to Rs 1,000,000 for death and total permanent disability due to an accident.

SLT-MOBITEL Fixed and Mobile users are entitled to these benefits and will receive an annual insurance cover equivalent to five times of their monthly bill value.

For example, if the bill value is Rs. 5,000/- during the month of January 2023, they will be entitled to a cover of Rs. 25,000/-. In February, if the bill value is Rs 6,000/- they will be entitled to a cover of Rs. 30,000/- and accumulated cover by end of February will be Rs 55,000/.

Likewise, this cover will accumulate as and when bills are paid. Each cover will be valid for a period of one year. Cover given for each bill will have a policy period of one year and will accumulate until it reaches a cap of Rs 1 Million.

A very nominal premium will be charged for each cover such that they do not feel any financial burden to pay the small amount. For example, for a cover of Rs. 25,000/- which will be valid for one year, the premium will be only Rs. 100/-.

Commenting on the Ceylinco SLT-Mobitel Ananthaya scheme, Ajith Gunawardena, Chairman of Ceylinco Insurance PLC (the holding company of Ceylinco General Insurance) said.

“Ceylinco General Insurance has served the people of our nation with the finest in innovative insurance products and services, which is an inbuilt component in the company’s DNA. Leveraging on this expertise, we have designed this unique product of high value thereby enabling SLT-MOBITEL customers to enjoy the benefits as long as they are covered under the scheme.

Also, this unique scheme addresses a compelling need of the people for affordable health insurance cover for serious illnesses at a premium that is negligible.

Considering ever-increasing medical costs, this benefit will undoubtedly ease the financial burden on our people to a great extent. We are more than happy to join hands with SLT-MOBITEL to launch the ‘Ceylinco SLT-Mobitel Ananthaya’ insurance scheme which will be expanded to other sectors as well.”

Ceylinco General Insurance has already obtained a patent for the ‘Ananthaya’ product and several corporates in the country have expressed their willingness to get on board with Ceylinco General Insurance as partners.

This product process won the ‘Innovation of the year’ award at the Asia Insurance Awards’ held in Singapore.

A major international project that will help reduce marine plastic litter from maritime transport and fishing sectors is up for a successful start, after getting 30 countries including Sri Lanka on board.

Sri Lanka has joined the Initiative as a partner country while India joined as a Lead partner country.

Solutions have been sought to tackle marine litter in the Lakshadweep Sea between Sri Lanka, Maldives and India.

As part of the ‘Prevention of Marine Litter in the Lakshadweep Sea’ (PROMISE) project, funded by the European Union (EU) through the SWITCH-Asia Programme. Government institutions, academia, NGOs, international development organizations and tourism industry associations gathered in Colombo for a policy roundtable discussion recently.

The PROMISE project has organized a series of policy roundtable meetings to look at solutions to tackle marine litter in the Lakshadweep Sea between Sri Lanka, Maldives and India.

This was a follow-up meeting to the first policy roundtable meeting held last year. The second policy roundtable meeting focused on policy benchmarking and discussion around adaptation to challenges and gaps in the Sri Lankan context, followed by the design and development of policy prototype solutions.

The Head of Cooperation from the Delegation of the European Union to Sri Lanka and the Maldives, Mrs. Jenny Correia Nunes, delivered the keynote speech emphasizing that “while marine pollution is a transboundary issue, we need also to look at national solutions, considering that the economy of Sri Lanka depends substantially on its marine and coastal environments.”

The EU has been a driving force globally to achieve climate neutrality, and the PROMISE project can help the economies of Sri Lanka, Maldives and India to make a green transition and keep our seas clean.”

PROMISE is a 4-year project (2020-2024) supported by the European Union (EU) under the SWITCH-Asia Programme.

It promotes sustainable consumption and production in small and medium enterprises (SMEs). The project activities target tourism clusters located along the Lakshadweep shorelines in the Maldives, Sri Lanka and India.

It aims to prevent the leakage of wastes from land-based sources into the Lakshadweep Sea. The project is implemented by the Maldives National University (MNU), in collaboration with Parley for the Oceans, the National Cleaner Production Centre, the Energy and Resources Institute, STENUM Asia, and adelphi research.

Sri Lanka is set to lose the massive economic contribution from around 18 German companies and affiliated firms operating in the dollar starved island nation if the government continues with import restrictions without easing it for the survival of international joint ventures.

German companies operating in Sri Lanka have raised the red flag with some warning they will be compelled to withdraw from the country if the import ban continues, informed sources with links to foreign firms disclosed.

Sri Lanka has slapped an import ban on several items owing to the shortage of US dollars, but Germany has urged the Government to relax the ban since 2021.

The German Ambassador to Sri Lanka Holger Seubert told a group of journalists in Colombo recently that some German companies have raised concerns over the import ban.

He said that if the import ban continues for another 2 years then some companies may withdraw from the country.

Even in November 2021 The German Ambassador has urged Sri Lanka to end import controls which have blocked vehicles and other goods since2020, as money printed to keep rates low created dollar shortages and depleted foreign exchange reserves.

Though total imports went up as credit recovered and funds went into areas not controlled by interventionist bureaucrats, items that brought high levels of taxes such as cars remained barred.

Amid Sri Lanka’s import controls the usual trade surplus with Sri Lanka has widened even further, Germany’s Ambassador to Sri Lanka Holger Seubert said on November 24,2021. He said Germany generally stood for free and fair trade

Just recently leading Japanese companies Mitsubishi and Taisei announced they will be scaling back operations in Sri Lanka owing to the economic crisis. Germany has also suspended issuing loans to Sri Lanka after the island declared bankruptcy.

However, the German Ambassador said that they hope the situation will improve once Sri Lanka’s deal with the International Monetary Fund (IMF) gets approved. Seubert said that there are also concerns over the overall business environment for German investors.

Discussions in this regard have been held with the Sri Lankan authorities, including the Board of Investment (BOI).

Germany is Sri Lanka’s second largest investor from the European Union. Many of the German companies operating in Sri Lanka are global leaders in their field of specialization.

The investment areas include apparels, hosiery knitwear, surf sails, textiles, electronic products, light/heavy engineering, rubber based products such as tires and automobile spare parts, coir products, wooden/soft toys, chemicals and dyes, gems and jewellery, tourism and recreational projects.

Leading German companies operating in Sri Lanka include:Kramski Lanka (Pvt) Ltd (Kramski GMBH Germany) – Steel/High precision moulds,Aqua Dynamics (Pvt) Ltd – Windsurfing sailsBASF Finlay (Pvt) Ltd – Chemicals,Bodyline (Pvt) Ltd (Triumph International) – Foundations garments,Eskimo Fashion Knitwear (Lanka) Ltd – Knitwear and Globe Knitting (Pvt) Ltd – Knitwear

Among the other German companies are Boehm & Leckner Multi Moulds (Pvt) Ltd – Tools/ injection moulds,Dial Textile Industries Ltd (Adolf Ahlers AG) ,Lanka Hiqu Ltd – Magnetic heads,Prestige Automobile (Pvt) Ltd (BMW) – Automobiles),