SL Inflation Success Fiction - Showing leaves to those who are unaware (aware) of the tree?

 

The picture below is the CB Communications press release. I was confused to understand what CB Communication Director intended to tell the public whether;

• His Governor made a presentation on Sri Lanka's inflation success story to a Forum in Germany or on Sri Lanka's inflation control success story,

• European Central Bank (ECB) President Christine Lagarde spoke at the event of SL Governor's presentation or at some other event of the Forum, and

• the intended message of this communication and its purpose are in the observance of public trust attached to officials of the CB.

Anyway, I am not surprised of the pictures as top level public officials these days has a fondly habit of communicating of their pictures with the international icons to the public, possibly to impress the public of their ability to resolve the present bankruptcy of the country.

However, I felt whether the CB Governor and Communications Director have attempted to show leaves to those who are unaware of the tree or other way around.

Therefore, the purpose of this article is to provide a few comments in that regard in the public interest.

Berlin Economic Dialogue

The Forum has been organized by the French Federal Ministry of Finance on the subject of “Inflation Kills Democracy: Fiscal Rationality as the basis of Functioning Communities”. Therefore, a few concerns over the CB press release are raised as below.

• This Dialogue has no relevance to inflation success or inflation control success stories of central banks in general. 

• Both French Finance Ministry and French Central Bank have no statutory duties in inflation in France as it is the responsibility of the ECB for the Euro Zone and, not specific to any ECB member countries. The French Central Bank has no money printing or monetary policy arm. That is why the Dialogue has been meaningfully titled on democracy of inflation where the democracy is the sole responsibility of the governments.

• ECB President Christine Lagarde is a former French Finance Minister who was then promoted to the Managing Director of IMF and thereafter to the ECB President. Therefore, her participation in the Dialogue is not a bizarre event.

• The CB press release does not state whether ECP President specifically participated as a discussant at the event of the CB Governor's presentation. Therefore, the ECB President's event picture is an unauthorized electronic bud to attach an undue prominence to the CB Governor as his picture is not seen anywhere at the ECB President's event.

CB press release not telling Sri Lankan inflation success story presented at the Dialogue

The article does not reveal the contents of the CB Governor's presentation. Therefore, what he told Forum about causes behind high inflationary pressures during 2022/2023 and policies that brought inflationary pressure magically down close to zero by October 2023 are not known. What ever he said, they most would have been new to the participants at the forum as the inflation story in France and Euro Zone is quite deferent from Sri Lanka.

However, the press release states that the CB Governor discussed the measures taken by the Central Bank and the Government in curtailing inflation. This shows that, without the government's support, the CB would have failed in controlling inflation although it is the statutory responsibility of the independent CB. 

It also raises concerns over the public accountability and trust encrypted in the CB as it has lost the price stability duty in the wake of high inflationary pressure. Inflation control does not mean curtailing inflation when it has risen. It means keeping price stability at all times.

In that context, the conduct of monetary policy for inflation target of 5% (inflation targeting monetary policy) in the medium term is a gross violation because prices will double in 14 years if prices rise by 5% annually as the CB permits in the monetary policy. That means that the value of currency issued by the CB will be worth nothing after 14 years. This is not the price stability mandate of the CB.

According to the press release the CB Governor may have shown the policy measures adopted from April 2022 and how inflation number fallen unexpectedly from the peak in September 2022.

Inflation control measures

The CB Governor would have highlighted fiscal and monetary policies in this regard.

Modern tribal monetarists believe inflation as always every where a monetary phenomenon caused by protracted budget deficits. They fail to understand simple market mechanism behind price changes. Therefore, their eye-closed policy package of robotic accounting mode is the fiscal and monetary tightening. Therefore, the CB Governor may have elegantly listed such fiscal and monetary policy measures by memory. 

• Among fiscal measures, tax increases, control of spending, social security spending policy to protect poor and vulnerable persons and IMF programme would have listed because they all are considered as promising control of money creation from fiscal front.

• Among monetary tightening measures, a sharp increase in policy interest rates by 10% from April 2022 to March 2023, bank order to raise interest rates, a guidance exchange rate in May 2022 to curtail the currency volatility, restriction on standing facilities to banks in January 2023 to activate the inter-bank market, curtail of monetary financing of the budget and new legislation to independent monetary policy by the CB would have been blindly listed.

• The Chart of inflation and policy rates would have been shown to convince the one-to-one success story of monetary tightening on inflation control as follows.

False Story: high interest rates busted inflation.

Rate cuts started with significant disinflation path. 

• Above chart does not know any natural relationship of policy interest rates with inflation. It is just a chart of two types of statistics over time. The relationship has to be established by the underlying economic story. However, there is no any fabulous theory that establishes the impact of policy rates changes on the behaviour of inflation other than monetary faith.

• According to the faith of tribal monetarists, the price stability/inflation control is the pre-condition for everything under the sun for the well-being of the human being and the central bank interest rate is the divine stick to run human prosperity through the maintenance of price stability/low inflation. However, they do not tell the public that it is only their faith not proved by any real world economic research.

Untold truth behind high inflationary pressures in Sri Lanka

In the recent past, Sri Lanka is one among few countries which confronted galping inflationary pressures due to country governance problems where inflation monetary theory does not apply. If the central bank is the divine in price stability in public legislation, the central bank also should be a part of the failure of the country governance in times of high inflation.

Therefore, reasons behind overshooting inflationary pressures in Sri Lanka seen from the beginning of 2020 is the layman knowledge.

• Disruption in supply chains across the globe due to global corona pandemic and anti-pandemic state policies such as social distancing and lockdowns and protracted delays in recovery of supply chains. This is the core factor for global inflationary pressures. We do not need monetary theories to understand it. This is a fact even if the present CB Governor would have been the country's President. 

• Historic civil uprise on living difficulties consequent to economic disruption by the pandemic. Everybody knows natural marker price pressures from such mass social uncertainties with or without government. In fact, the CB Governor also no sooner assumed the duties to save the nation offered to resign in the middle of the civil cum political crisis while the former Governor also stepped down in 8 months. That shows the degree of macroeconomic instability shock undergoing the economy and general public at that time that has no relevance to the monetary theory of inflation.

• Collapse of the CB foreign reserve as the CB could not find top-up-funding. As a result, imports were suspended and exchange rate control was given up. As Sri Lanka has been an import-dependent country for decades funded by the CB foreign reserve, the suspension of imports and controlled exchange rate caused severe shortages of imports and skyrocketed import prices and all local prices. The removal of administered prices on import dependent products also pushed up prices overnight. It is not a secret that the growth, prices and inflation in the economy for decades were desirably controlled by imports, fixed exchange rate and administered prices financed by the CB's foreign reserve that was built on government foreign borrowing. 

• Public declaration of default of government foreign debt by the CB on 12 April 2022 due to the CB's default on the foreign reserve caused a sudden bankruptcy of the country. This was not a default of the sovereign currency issuer (government), but a default of the CB on its foreign reserve to repay foreign debt. However, the default was accounted in government as such foreign debt was accounted in government books although foreign currency proceeds were used by the CB. As a result of this unethical default, all international trade and finance transactions of the country were disrupted and the government could not import petroleum products and energy. This broke the power backbone of the economy and living conditions as seen from long ques. This led to the second round of supply shortages and price increases across the economy.

• The erosion of earing from tourism and remittances that were used to finance the foreign trade deficit also affected the supply side and foreign reserve. Tourism was a direct pandemic effect. The significant drop in remittances through banking/official channels was a result of anti-government political campaign and black market developments connected with foreign exchange market uncertainties. However, black market did not confront shortages in foreign currency.

• The cost-side impact of significant monetary tightening is a normal phenomenon in modern monetary economies. The CB's forceful intervention in accelerating of Treasury bill yield rates and bank deposit and lending rates to 25%-35% within few months from April 2022 from 8%-15% before requires no macroeconomic models to prove both cost-pushed and contraction-pulled inflation as it is common business sense. There is no disagreement that massive supply side contraction in 2022 and 2023 was fueled by sugar high interest rates which is the opposite of monetary policies prescribed for crisis-hit economies.

• The fiscal tightening also has disrupted almost all supply chains surrounding fiscal spending as it is the major part of macroeconomic multiplier in any economy. Therefore, arbitrarily created fiscal disarray also has contributed to the supply side contraction and price escalation across the economy. 

In view of above, Sri Lankan economic crisis is the direct outcome of the failure of the CB in managing the foreign reserve and monetary policy for decades in public interest which largely caused high inflationary pressures. Therefore, tribal monetary faith behind high inflationary pressures in Sri Lanka is a gross myth and fiction.

Disinflation/inflation success lie

The inflation success story presented by Sri Lankan authorities simply lies on textbook version of fiscal and monetary tightening as required and supported by the IMF. However, the reality is that this success story is grossly incorrect due to several facts.

• First, the sort of interim political stability and protest control system has settled large uncertainties in civil society and markets. Therefore, price escalations have been dried up gradually. This is what policy authorities led by the CB Governor referrer to as significant disinflation due to prudent policy measures implemented by the government and central bank. Therefore, this is a sheer eye-wash. In contrast, central banks in the rest of the world are expected to stay on the tightening cycle for long time as global inflationary pressures have not been tamed so far. However, the fact that Sri Lankan Central Bank commenced cutting interest rates at the time of inflation stood at historic 35.5% in April 2023 after a rate hike by 1% in March 2023 on the advice of the IMF does not involve in any monetary theory.

• Second, prices and cost of living in the country have not eased by the disinflation path. The disinflation or inflation control refereed to by policymakers is a statistical calculation. That is the year-on-year growth of the consumer price index (CPI). Therefore, this calculation does not represent inflation or the increase in prices in general over the crisis period, i.e. from 2000 to present, and the prevailing cost of living escalated during the crisis period. Therefore, this is a dump calculation used to serve only those tribal monetarists who have no idea of ground conditions of living standards. This is revealed by continued increase in the CPI and high rate of period-based inflation. Following charts are self-explanatory in common sense. (CPI numbers are statistically integrated into CPI base 2013=100.). In that context, monetary policy inflation is a fictitious base-decided inflation and not a market phenomenon.

• Third, although brave talks are given on monetary tightening to control prices and inflation through the demand side of the economy, money stocks and credit creation have continued rise to fund basic economic activities at significantly rising credit and interest rate risks invoked by the CB's monetary policy. However, sugar high interest rates and business bankruptcies have led to deceleration of credit creation for the private sector offset by the state sector which has saved the economy at least at this extent. Following charts are self-explanatory in common business sense without any monetary theories. Any of charts doesn't show monetary reduction to cut down the demand in the economy and to control inflation. It is strange that monetary figures are lagged in more than two months despite the modern on-line banking IT systems.

• Furth, the fabricated story of fiscal tightening to control inflation is also a lie as fiscal spending and borrowing have continued to rise in 2022 to 2023 with increased gross borrowing requirement.
• Spending rose from Rs. 4,473 bn in 2021 to Rs.5,253 bn in 2022 and Rs. 6,978 bn in 2023.
• Gross borrowing limits rose from Rs. 3,200 bn in 2021 to Rs. 4,979 bn in 2022 and Rs. 7,350 bn in 2023.
• As shown by monetary charts above, the economy would have collapsed with many households begging on the road unless the Government had spent through money creation/monetary financing irrespective of its monetary label. It was the ground fact in all countries despite inflation monetary theories.

Public Concerns

• The face of above short presentation that does not involve in any serious economic research reveals that the inflation success story proclaimed by the Central Bank and Government is a baseless lie.

• In that context, the presentation made to Berlin Dialogue also seems to contain unethical motives.

• In the present crisis-hit economy, public officials are bound to serve in compliance with Directive Principles set out in the Constitution and public trust legislatively assigned to them in public mandates.

• Therefore, public officials must genuinely base their work on ground facts and current needs of the public for upliftment of living standards by setting aside untested tribal faith in economic theories and concepts.

• The present IMF-sponsored macroeconomic governance system built on separated monetary and fiscal spaces and demand control under the guise of debt unsustainability and restructuring is meaningless in terms of facts-based modern monetary and supply side approaches. Therefore, the country will not be able to come out of the present economic crisis of living standards and poverty for decades although the authorities will clean up the old set of macroeconomic numbers such as inflation estimates that fall within their purview to fabricate macroeconomic stability fictions.

• However, their task at hand is nothing but humanity that should help people to spend a respectable living span which is not dependent on faith in tribal monetary theories. This cannot have any more financial or number crunching games to be played with human lives.

(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 12 Economics and Banking Books and a large number of articles published. 

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)