ECONOMYNEXT – Sri Lanka has to go beyond a four year stabilization program of the International Monetary Fund and grow the economy, dealing with the ethnic question, President Ranil Wickremesinghe said.
Sri Lanka had to bring back monetary stability after the central bank printed money to suppress interest and target an output gap, eventually running out of reserves and defaulting.
“What is our task? It is not just to stabilize the economy,” President Wickremesinghe told a seminar organized by the Institute of Chartered Accountants of Sri Lanka.
“It is to ensure growth. To grow in this new global economy. There are facts we cannot get away from.
“If we are to do this, we have to remember is that one of the biggest issues that held back our growth was the ethnic issue.
“We have to think as Sri Lankans. We cannot divorce that from economic issues. I am not dealing with that now, but we have to acknowledge it.”
Sri Lanka’s nationalism took wing after one of the first stabilization efforts in the 1950s.
The central bank was set up in 1950, abolishing an East Asia style currency board, giving economic bureaucrats the power to print money and run down reserves and pushing up prices.
Foreign reserves fell from 216 million US dollars in 1951 to 163.4 million dollars and in 1952 to 114.3 million dollars as the central bank printed money to suppress rates instead of keeping pace with the US as the Fed halted money printing and started tightening under then Governor Wade McCade after firing a global commodity boom.
In 1953 there was a hartal, after subsidies on booming rice prices were cut.
In the next two years, the deficit which had hit 5.8 percent was brought into surplus under a tight stabilization program but the government lost an election amid a rise in nationalism.
President Wickremesinghe said Sri Lanka had a chance to reform after a government came in 1965 based on a report by economist B R Shenoy, but had lost the chance.
Shenoy advocated a single anchor monetary regime – a clean float – instead of ad hoc pegging which will eliminate money printing and bring exchange rate stability and low inflation.
He was ignored. By 1969 after economists had printed money for agricultural credit, Sri Lanka’s import control law was brought.
It was used extensively to deny trade freedoms to the people in the 1970s in the Great Inflation’ period after the Fed broke the gold standard and the Bretton Woods system, critics say. It is even now in use after the 2020-2022 money printing bout.
Wickremesinghe said after 1977 Sri Lanka had another opportunity and the it was lost amid social unrest and war.
In 1980 after two years of strong growth, Sri Lanka’s foreign reserves which had increased to 516 million US dollar by 1979, fell to 245.5 million dollars and the country went to the IMF as then Fed Chief Paul Volcker tightened policy after the Fed ended the ‘second oil shock’.
In the subsequent years, Sri Lanka had some of the highest inflation and depreciation, and budgets became unmanageable.
The 1980s inflation was only exceeded under flexible inflation targeting/output gap targeting and the country defaulted, something that had not happened in the war years, based on official data.
In the late 1980s Sri Lanka had done another series of reforms. Sri Lanka had used global development to encourage apparel factories.
There were similar opportunities in green hydrogen, which had to be seized, President Wickremesinghe said.
The reforms had to be implemented so that a prosperous country could be provided for the young people, who were voting with their feet and leaving the country.
“If you want to give a future for your children, if you want to give future to the youth, then you have to go forward,” Wickremesinghe said.
Sri Lanka is at the cross road of stagnating or becoming a prosperous country, he said.
“Sri Lanka is today at the cross roads between seizing the opportunity for growth to fix our longstanding institutions and stuctural probelms and to become a prosperous society or denying our problems and rejecting change and stagnating as a lower middle income country,” Wickremesinghe said.
Wickremesinghe said there would be a market determined flexible exchange rate and reserves would be re-built under the IMF program.
Analysts however say exchange rates are not determined by the market as claimed by Mercantilists but by the monetary anchor operated by the monopoly state enterprise which produces money.
If anchors conflict – it has both a monetary and exchange rate policy – as in flexible inflation targeting the currency will collapse as soon as domestic private credit recovered.
Several countries which had operated flexible inflation targeting with the reserve collecting pegs (conflicting anchors) had collapsed and defaulted.
Ghana, which defaulted recently, is one of the earliest countries to adopt flexible exchange rates with flexible inflation targeting in 2007 instead of true inflation targeting.
Since 2007, the Ghanian New Cedi has collapsed from around 7000 to 120,000-140,000 in the course of printing money to generate 8 percent inflation.
Sri Lanka was flexible inflation targeting to generate 5 percent inflation when the currency initially fell from 131 to 182 to the US dollar from 2015 to 2019.
From 2020 when both taxes were cut and money was printed to target an output gap, the currency collapsed to 360/370 to the US dollar. It is now around 320/330 with ad hoc pegging. (Colombo/Mar30/2023)