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Sri Lanka plans to compete with higher-wage countries amid currency collapse

Mar 28, 2019 07:49 AM GMT+0530 | 0 Comment(s)

  

ECONOMYNEXT - Sri Lanka has to compete with a set of countries which have higher wages, instead of trying to beat low-wage nations like Bangladesh and Myanmar, Economic Reforms Minister Harsha de Silva said, as the Central Bank depreciated the rupee to cut real salaries of the people and lower living standards.

Two Paths

"We have two choices," de Silva told foreign correspondents in Colombo. "One is to go down and take salary cuts and say we will become a low wage producer and then compete with the Bangladeshis, compete with the Myanmar people and so on.

"Another option is to take ourselves up from where we are and compete with another group of countries. So in that group of countries, we have Malaysia, Thailand, some of the new Eastern European countries, and so on."

"Falling below is not an option. Go up is the only option."

Malaysia and Thailand are countries with exceptional central banks which gave stability and protected salaries of the people without fancy monetary policy generating instability.

After the break-up of the Bretton Woods system in 1971, the Bhat remained at the earlier parity of 20 to the US dollar until around 1980, when extreme monetary tightening by the US under Paul Volcker, who pushed policy rates to 18 to 20 percent, and similar policy in the UK put pressure on the peg.

The Bhat was re-pegged 25 and remained until the East Asian soft-peg crisis through its Asian Tiger growth period until 1997, when it fell to 46 in a float and recovered. It is now at 31 to the US dollar.

Malaysia had a currency board with Singapore and after the break-up of Britain Woods soft-peg system, it appreciated from 3.0 to 2.1 by 1980. After weakening from 1980, it was re-pegged at 2.5 until the East Asian crisis, when it fell to 4.2 in a forced float.

The Malaysian Ringgit is now at around 4.0 and has seen greater volatility than higher-income countries like Korea.

Singapore, which has a modified currency board is now a high-income country and has seen its currency has appreciate from 3.0 to 1.2 to the US dollar from 1971 to 2019.

Sri Lanka's currency on the other hand collapsed from 5.9 in 1971 to 15 by 1977. After remaining stable at 15 until 1980, it started collapsing when the US dollar started to tighten. Budgets deteriorated as the currency collapsed and inflation soared.

From 1980 to 2014, the rupee collapsed from 15 to 130 to the US dollar by 2013.

Monetary Dominance and Unsound Money

Since the current administration came to power in 2015, the rupee had collapsed to 180 from 130 to the US dollar amid unusually reckless money printing, especially in 2018, and targeting a real effective exchange rate index to cut real wages without having a floating policy rate to target any exchange rate. In March the rupee appreciated to aroudnd 177 to the US dollar.

The Central Bank's strategy of unsound money, generating monetary instability generally, and cutting real wages with REER targeting goes directly against Minister de Silva's idea of competing with high wage countries.

"You know that the Central Bank and I have not seen eye-to-eye on some issues over the years," de Silva said.

"Not this Central Bank and this government, I have been making this argument ever since I came back with training economics in 1993. From that day, I have maintained a certain position about the Central Bank.

"Where it is independence should be and how fiscal dominance should not be the reality on the ground."

"I do not believe that depreciating the currency to beyond what is necessary to become competitive … with countries that are below us currently. That is not what we want. We want to be competitive with countries that are ahead of us. Not countries who are below us."

De Silva had campaigned to give more independence to the Central Bank and end fiscal dominance of monetary policy (the Treasury forcing the Central Bank to print money).

De Silva played a major role in creating awareness that inflation was a monetary phenomenon, and it was not caused by oil or diesel prices, bringing the onus on the central bank not to generate very hihg levels on inflation.

But the Central Bank's recent conduct where it persuaded the Treasury to bring in trade restrictions on gold and other imports, discrediting a free trade agenda of the current administration to cover its own policy errors have brought the question of monetary dominance of fiscal policy in to the forefront.

The IMF, which gave it a contradictory program involving a forex reserve targeting, which requires pegging, and an inflation target, which requires floating, however, has put conditions to halt trade restrictions for 'balance of payments purposes' in a failed bid to stop monetary dominance of fiscal policy.

De Silva is hopeful that planned reforms to the central bank law will help bring stability to the country.

Boosting Skills

De Silva says Sri Lanka has to make more complex and advanced products, which needs skills.

Currency depreciation makes it more expensive for young people to gain skills from abroad. De Silva says the 2019 budget is giving student loans for higher education and education reforms are key planks of helping Sri Lanka compete at a higher level.

Importing skills is another strategy to fast-track activity.

"We can organically grow the skillset or we can purchase it," he said.

"Like New Zealand purchased it. Or Dubai purchased it. Or like Malaysia is purchasing its skill set or America is purchasing its skill set.

"So we've got to create that environment where people could come here and engage in activity and they can benefit from themselves and the nation."

Dubai is a country which circulated Indian rupees at 4.70 to the US dollar just like Sri Lanka had a currency board at independence at 4.70 to the US dollar until the mone-printing Central Bank was created in 1950, generating instability, inflation, trade controls, exchange controls, and import substitution.

Dubai's Dirham, which was created after the Reserve Bank of India was nationalised and was used by Prime Minister Nehru to print money and finance his 5-year Soviet style program and a separate Gulf Rupee also became unstable, has appreciated since its creation.

After gaining from 4.74 in 1971 to 3.7 by 1980, it fell to 4.2 by 1984. From 2000, the Dirham had been tightly pegged at 3.67 to the US dollar. The monetary authority of the UAE also does not follow fancy policy but simply piggy-backs on US policy.

Dubai also has no direct tax which has allowed it to generate jobs in a multiple of its own population while countries with income tax have unemployment.

Better Environment

De Silva says Sri Lanka wants to create an environment where Sri Lankans who had migrated abroad will come back with a good education.

At the moment, Sri Lankan expatriates with foreign or foreign passport-holding spouses do not want to return as part of the family income is lost.

De Silva says the administration is planning reforms to the visa system including spouse visas to remove obstacles to people returning.

"We want to be competitive with Israel, with Malaysia, with Latvia," de Silva says.

Isreal had severe monetary instability amid several wars. After inflation hit 450 in 1984, Israel went through a stabilisation program, involving strong central bank reform, where among other people, famed Israeli-American economist Stanley Fischer was an advisor.

After a stint at the International Monetary Fund, as First Managing Director where he saw the problems with soft-pegs during the East Asian crisis (Exchange Rate Regimes: Is the Bipolar View Correct?), Fischer became governor of Bank of Israel in 2005, making it a First World-style agency.

The Isreali Shekel hit 4.7 in 2006 and is now at 3.5 to the US dollar.

Lativa has a currency board like system with the Euro. Latvia dumped the inflating Ruble after gaining independence from the Soviet Union. The Lat has been at 0.7 to the Euro for years. (Colombo/Mar28/2019 - Update II-SB)


 

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