ECONOMYNEXT – Sri Lanka has been re-classified as a lower middle income country by the World Bank as per capita income dropped amid real effective exchange rate and flexible inflation targeting which brought currency collapses and growth rates below inflation.

Sri Lanka’s per capita gross national product (GNP) dropped over 200 dollars from 3,968 dollars in 2018 to 3,741 dollars in 2019, while per capita gross domestic (GDP) product dropped from 4,079 dollars to 3,852 dollars following a currency crisis triggered which brought stagflation.

Monetary Instability

Sri Lanka has been following a combination of Real Effective Exchange Rate (REER) targeting involving deliberate devaluation of the currency run ahead of inflation, generating fresh inflation in the process and ‘flexible’ inflation targeting with consumer price target high enough to trigger involuntary currency collapses.

Monetary instability had worsened in peacetime, with currency crises coming with smaller gaps, compared to the latter part of the island’s long-running civil war with policy becoming more discretionary and pro-cyclical.

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In 2018 a pro-cyclical rate cut in April was followed by liquidity injections, which was combined with a so-called buffer strategy for bond sales, involving overdrawing state banks re-financed with lender of last resort money, just as the credit system was recovering from a 2015/2016 crisis.

Sri Lanka’s per capita GNP also dropped from 3,969 US dollars in 2017 to 3,968 dollars in 2018 following a 2015/2016 currency collapse which was also triggered by pro-cyclical rate cuts and liquidity injections amid a sudden expansion of the budget deficit in 2015.

The last administration gave the central bank full independence to target the REER and also engage in pro-cyclical rate cuts, though there have been calls to reform the central bank, restrain its domestic operations, curb discretionary policy in a bid to bring monetary stability and sustained growth.

In 2020, however the central bank had come under pressure to print more money, and it has lost forex reserves. But private credit had slowed by April 2020, amid Coronavirus lockdowns. Sweeping import controls have also been brought after money printing.

Adjusted Threshold

The World Bank adjusts per capita Gross National Income using a so-called Atlas Method which seeks to smooth the effects of currency volatility and inflation.

The World Bank calculated Sri Lanka’s gross national income in 2019 to have fallen to 4,020 dollars from 4,060 dollars in 2018, under the Atlas Method.

The lender’s threshold for upper middle income countries also moved up to 4,026 dollars in 2019 from 3,996 dollars in 2018, which it said was due to inflation of special drawing rights, a composite denominator currency devised by the International Monetary Fund.

The classification is done every year at the beginning of July.

With per capita income rising Sri Lanka graduated out of World Bank’s cheapest loans from the International Development Association window in 2017.

However other countries which have seen GDP contract has ‘reverse graduated’.

Fellow Travellers

Indonesia and Philippines which also had bad central banks with depreciating currencies have ‘reverse graduated’ into IDA and graduated again. They are among the worst performers in the ASEAN.

The Philippines’s central bank was set up by John Exter, an American, with similar extensive discretionary powers as Sri Lanka’s central bank. The country haas experienced severe monetary instability and export of labour to the Middle East and or East Asian countries with greater monetary stability.

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Meanwhile Nepal, where the Nepal Rastra Bank follows less discretionary policy but is pegged to the Reserve Bank of India, whose policy had also worsened in recent years, rose to a lower middle income country from a low income country.

Indonesia became an upper middle income country again with per capita income of 4,060 US dollars.

Other countries that regressed with Sri Lanka include Sudan, whose per capital GNI fell from 1,560 dollars to 590 dollars.

“For Sudan, the GNI series for 2009-2018 has been revised as a result of revisions to the exchange rates,” the World Bank said.

The Sudan pound has collapsed from 18,000 in 2018 to 55,000 this year.

Algeria also regressed from 3,970 US dollars in 2019 from 4,060 in 2018. (Colombo/July02/2020)