2025 & Beyond - A contracted, deflationary economy with failed monetary policy. Clean Sri Lanka to rescue the economy or nobody's accountability?

 


Article's Purpose

The purpose of this article is to highlight grave concerns over the monetary policy that has miserably failed to maintain the price stability in the year 2024 as set out in the statute and its likely contagion over the year 2025 and beyond.

What is the price stability mandate?

It is the maintenance of percentage increase of the quarterly average consumer price index within 3%-7% with a hypothetical middle target of 5% as set out in the monetary policy framework agreement reached between the Minister of Finance and Central Bank (CB) inconsistent with the current macroeconomic fundamentals of the economy.

Why price stability has failed?

  • The economy has confronted a four-month long deflationary trap with nine months violating the mandatory 3%-7% inflation target. The CB also predicts deflationary trend to be continued in 2025 and 2026 too.


  • The manner in which inflation fast accelerated in 2022 and decelerated in return-post in 2023 and 2024 is self-explanatory for price instability despite the CB mandates.

  • In Economics 101, deflation is the direct outcome of the tight monetary policy as well as the tight fiscal policy. This is the opposite of hyper-inflation alleged in 2022 attributable to reckless money printing (monetary policy) and fiscal deficit (fiscal policy). Therefore, various micro factors such as administrative prices and seasonal factors cited by the CB as reasons for deflation are irrelevant in the monetary policy and inflation target. The CB's mandate is not on such prices but on the overall price level influenced by the demand and money.

  • Therefore, the present deflationary trap is the continued lagged effect of the official macroeconomic management policy adopted for the contraction of the economy in 2022 and 2023 and continued unofficially in 2024.

  • Therefore, deflation plus contraction is the legacy of the former President passed on to the new President to clean up.

Why monetary policy instruments are irrelevant?

  • Failed price stability mandate itself is the evidence for failed instruments of text books that kept monetary and credit conditions tighter supported by the restrictive fiscal instruments than what were required for weak macroeconomic fundamentals of the economy.

  • Those monetary policy instruments used in 2024 were;

    • statutory reserve ratio of 2%, 

    • policy interest rates reduced by 1.50 to 7.50%-8.5% (SDFR and SLFR) to drive the corridor for overnight inter-bank lending rates,

    • introduction of a new overnight policy rate in November 2024 as another hypothetical target for the overnight inter-bank lending rates in addition to SDFR-SLFR policy rates corridor and 

    • excessive reverse repo auctions primarily to supply reserves (or printing money) for payments settlements at interest rates lower than policy rates while pushing down the overnight inter-bank lending rates towards the lower policy target bound.



  • It is needless to state that, as inflation mandate has been breached, monetary policy instruments that were implemented as shown above also have miserably failed.

  • In response, all central banks state that they operate the monetary policy with objectives and instruments authorized by the Parliament where the price stability will be achieved in the medium and long-term. However, the fact is that the price stability never realizes and nobody monitors the medium and long-term.

What are public concerns raised over policy instruments?

  • Public allegations were abundant that reverse repo auctions were used to print money excessively to support the dealers despite the abundant daily liquidity prevailing in the market.

  • Allegations were specifically targeted over printing of reverse repo money at significantly lower interest rates than the policy lending rates. The loss to public property on such reverse repo auctions is estimated to be around Rs. 10.6 bn in 2023 and Rs. 12.8 bn in 2024 (total of Rs. 23.5 bn).

  • Over the heat of such allegations, the CB has not offered reverse repo auctions after 10 December 2024 where inter-bank interest rates were stabilized at the middle policy rate as against below the middle policy rate with abundant reverse repo money printing auctions before.

  • Continued deflation in the severely contracted economy is being alerted as the significant threat to the national economy and financial system with over 12% of non-performing bank loan position and private sector disputes over restructuring of bank loans.

Concluding Remarks

  • In Economics 101, deflation trap is the outcome of the contracted demand by the unnecessarily tight monetary and fiscal policies. There is no debate over it in classical economics practiced by central banks and international economists led by the IMF and World Bank.

  • The CB also predicts the continuation of deflationary trend in 2025 and beyond.

  • The price instability against the agreement with the government on the inflation target framework is a clean statutory breach by the CB's Monetary Policy Board.

  • Macroeconomic and financial system risks underlying the contracted and deflationary economy have now been passed by the former President to the new President in the capacity of the Minister of Finance.

  • Therefore, such risks may also be consolidated in the Clean Sri Lanka Policy launched toady as no Clean Sri Lanka can prevail without a clean monetary system that serves its statutory responsibilities to the letter and spirit.

  • In that context, Clean Sri Lanka should require the CB to clean up the monetary policy with new purpose and instruments in the national economic interest. This will be a system change.
(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. All are personal views of the author based on his research in the subject of Economics which have no intension to personally or maliciously discredit characters of any individuals.)

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 13 Economics and Banking Books and a large number of articles published.)

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