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Friday December 8th, 2023

Sri Lanka has a corrupted inflation targeting, output gap targeting not in line with monetary law: Wijewardena

ECONOMYNEXT – Targeting an output gap with printed money is not in line with the original intentions of Sri Lanka’s Monetary Law Act and ‘flexible’ inflation targeting is a corrupted version of the original, a top economist and former central banker has said.

Contradictory money and exchange policies (trying to maintain an exchange rate after printing large volumes of money to keep rates down and boost growth or target an output gap) has led to the collapse of the rupee from 131 to 202 so far in three currency crises since 2015.

However Sri Lanka’s Monetary Law Act, the constitution of the central bank does not have a growth mandate, to target the output or growth.

Violating MLA intentions

“Output gap targeting does not comply with the original intention of the economic and price stability objective that has been incorporated in the Act,” former Deputy Governor of the Central Bank W A Wijewardena told EconomyNext.

The MLA says “the Central Bank is hereby charged with the duty of securing, so far as possible by action authorised by this Act, the following objectives, namely –

(a) economic and price stability; and
(b) financial system stability,

with a view to encouraging and promoting the development of the productive resources of Sri Lanka.”

Wijewardena says the Central Bank is trying to push the aggregate demand curve to the right by injecting liquidity.

However the MLA does not give any authority for the central bank to print money to try shift demand higher and de-stabilize the balance of payments and the overall economy.

Wijewardena has explained why the then-Central Bank Govenor Jayewardene put the ‘economic and price’ stability as an objective because only focusing on an inflation index may lead the central bank astray.

Wijewardena in his previous writings recalls Jayewardene telling him: “…if you have only price stability, then you would fall into the trap of attempting to stabilize a price index which is not what is meant by price stability, in the context of a central bank. The attainment of price stability for a central bank means elimination of both excess demand and excess supply in the market so that the market is free of potential inflationary or deflationary pressures”

Analysts say when classical economists originally coined the word ‘inflation’ it did not refer to just an index compiled by a state agency.

Inflation referred to the expansion of reserve money (inflation of fiat injections) beyond the specie stock (gold reserves) of a central bank which led to assets price inflation, balance of payments trouble (export of gold like modern forex shortages) and mal-investments by an over-expansion of credit.

The problem was graphically shown when the US Fed, targeting a core-inflation index which excluded commodities, triggered a massive housing and commodity bubble, which collapsed in what is now called the Great Financial Crisis.

In 1971 the Fed had already ended a gold standard by trying to target an ‘output gap’.

Eliminating Conflicts

The danger of focusing only on an inflation index also was that it could be manipulated.

Then Governor A S Jayewardene had transferred responsibility of calculating both the output and inflation to the Census Department to avoid any conflict of interest, Wijewardena said.

Jayewardene revised the Monetary Law Act as part of a drive to shift to inflation targeting which however requires a fully floating exchange rate.

An earlier requirement to maintain the external value of the rupee was dropped.

When a US Federal Reserve official built the central bank in 1950, to join the Bretton Woods system of failed soft-pegs, the rupee was defined as 2.88 grains of gold, .

The peg would have put the brakes on credit expansion and maintained the exchange rate, if rates were allowed to rise in time and credit curtailed.

Under the Bretton Woods both Germany under Austrian economic influence (4.2 to the US dollar) and Japan (360 yen to the dollar) showed that it could be done .

However in Sri Lanka the central bank placed import and exchange controls to maintain the exchange rate, while financing the deficit, instead of allowing the credit system to adjust to the balance of payments.

Before the setting up of the soft-peg in 1950 which brought forex shortages and currency crises, Ceylon had a hard peg (currency board) from 1885, where the exchange rate was fixed by allowing short term rates to float in line with the balance of payments.

Given the experience of trade and exchange controls up to 1977 and the currency collapses and high inflation after that, the Monetary Law Act was revised to clearly maintain stability so that economic agents could carry out real growth generating activities.

Jayawardene also stopped central bank re-finance of rural credit which had directly contributed to the currency collapses, high inflation and the inevitable high interest rates, that are required to stabilize the economy the 1980s.

Corrupted Inflation Targeting

Sri Lanka has triggered three currency crises in 2015/2016, 2018 and is now in the middle of the third as rule based monetary policy was jettisoned in favour of highly discretionary ‘flexible’ inflation targeting and ‘flexible exchange rate’.

Under ‘flexible’ inflation targeting, the real effective exchange rate, the yield curve and also lending and deposit rates were controlled to target an output gap targeting (growth).

The International Monetary Fund has been advocating ‘flexible inflation targeting’ to many countries which is a more discretionary form of monetary policy than that is followed by successful inflation targeting like Sweden, New Zealand and Australia.

“Inflation targeting has now been corrupted by a new concept called flexible inflation targeting,” Wijewardena said.

The IMF as part of technical assistance taught the central bank to calculate and output gap and may have been complicit in the economic instability that followed from the ‘flexible’ policy.

Whether the IMF broke the MLA by teaching the central bank to target an output gap which led to the money printing bout in 2018 and the subsequent currency crises and growth collapses has not been tested in court.

Supreme court justices in many countries including the US has not upheld monetary laws, due to the general lack of understanding monetary policy, though counterfeiting is generally understood by most.

However public awareness of central bank policy errors are growing in Sri Lanka.

Earlier in 2021, Chandra Jayaratne, a public interest activist made a public appeal for the central bank to engage in a public debate about its monetary policy as the balance of payments continued to deteriorate.

“I request that the Central Bank (CBSL) arranges a public participative intellectual debate, on a virtual platform, between the CBSL Team and invited economists, bankers and business managers with practical experience in business, consultancy and banking/finance, with the subject of the debate to be on the present external sector monetary management policies and practices,” Jayaratne wrote in February 2021.

“I make this appeal as I fear that the public image of the CBSL and the independence, professionalism and intellectual integrity of yourself and the CBSL Team, may come in to question, if not now, in the near future or even in the long term.”

The central bank declined to take up the offer.

In 2019 after the 2018 output targeting exercise triggered a currency crisis, despite taxes being raised and oil being market priced and import controls being placed, the central bank sent out a long statement about its monetary policy actions.

However in 2020 Sri Lanka is in another crisis.

Related: Sri Lanka’s central bank defends discretionary monetary policy

Not the People’s Fault

Sri Lanka is now mired in some of the worst import controls since 1970s when the central bank was injecting money by purchasing Treasury bills in a large scale.

In 2020, unprecedented volumes of Treasury bills had been purchased by the central bank under so-called Modern Monetary Theory.

The central bank’s Treasury bill stock has topped 900 billion rupees, central bank credit to government has exceeded reserve money – it is not clear whether there is any historical precedent for it in Sri Lanka, and forward exchange rate premiums are negative despite a run on foreign reserves due to low rates.

There is greater public understanding of the policy errors of the central bank, and the import controls that come in their wake.

Import controls imply that the public is doing something wrong to depreciate the exchange rate and not the central bank which is failing to manage reserve money.

Despite the worst import controls since 1970s, the rupee is continuing to fall. The rupee also continued to fall despite last administration ending gold imports and vehicle imports, blaming the people for a failure of the state.

Ross McLeod an Australian economist says, who studies East Asia currencies say the people cannot be faulted for currency depreciation, which is always the case of the central bank mis-managing, reserve money, a monetary variable that only it can created and control.

When central banks try to control both the exchange rate and interest rates (by expanding reserve money) the currency falls.

“Well, it’s not the people at all. It’s the policies of the central bank in all cases,” McLeod said in an interview with Advocata Institute in Colombo.

“There’s a demand for money from the people but the supply is determined by the central bank,”

“If then supply is made too large relative to the demand for it, or if the growth rate of supply is too rapid relative to the growth of demand for it, then just like everything else, the value falls.

“The value of money is its purchasing power. That’s kind of the inverse of the inflation rate. If you have the value of the currency falling, it is equivalent of saying prices are rising.

“So it’s never the fault of the people. It’s always attributable to the policies of the central bank.”

Countries that severely mis-manage reserve money could end up in dollarization. (Colombo/Apr12/2021)

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SLPP enjoying “great demand” from potential presidential candidates: Namal

FILE PHOTO – President Gotabaya Rajapaksa with nephew Namal at the opening of the last part of the Southern Expressway/PMD

ECONOMYNEXT – The ruling Sri Lanka Podujana Peramuna (SLPP) enjoys “great demand” from potential presidential candidates, and the party will have to take a call on working with incumbent President Ranil Wickremesinghe, MP Namal Rajapaksa said.

Speaking to reporters on Thursday December 07, Rajapaksa claimed several names have come up concerning the SLPP’s candidate at next year’s presidential election.

“There is great demand: entrepreneurs, businessmen, politicians, are all there. There are presidents too, ready to come forward with our party,” he said.

“Out of all these people, we will put forward on behalf of our party the candidate that can take the country forward while stabilising the economy,” he added.

Commenting on continued support for President Wickremesinghe, Rajapaksa said the while SLPP at present works with the former in the present government, the party will have to decide whether that relationship continues going forward.

“The matter of whether we work with the United National Party (UNP) in the future – this is not a politics dependent on individuals; the SLPP is a party. We will talk as a party with other parties, but no discussions will be held centred around individuals,” he said.

Rajapaksa noted that Wickremesinghe was the only member of parliament representing the UNP at the time of his election by parliament following the resignation of his predecessor Gotabaya Rajapaksa .

“If we are to collaborate with the UNP in the future, we’ll have to discuss that. Once the party has decided on that, we can get a start on those discussions. Today, we work with the president in the present government,” he said.

Last month, when asked to comment on President Wickremesinghe’s 2024 budget, MP Rajapkasa sounded rather sceptical of the president’s ambitions for turning the crisis-hit economy around.

“We must study the budget. He had presented a lot of these proposals in last year’s budget too. They don’t seem to have been implemented,” Namal Rajapaksa said, speaking to reporters after the budget presentation Monday November 13 afternoon.

Rajapaksa’s father and leader of the SLPP former president Mahinda Rajapaksa, however, spoke in favour of Wickremesinghe’s budget.


Sri Lanka’s “forward-looking” 2024 budget will instill fiscal discipline: MR

While not without its shortcomings, the older Rajapaksa said, the 2024 budget is a forward-looking one that aims to ensure fiscal discipline and put Sri Lanka on the path to recovery. (Colombo/Dec07/2023)

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Sri Lanka ruling party MP contradicts poll to claim his party is overtaking president’s

ECONOMYNEXT – The ruling Sri Lanka Podujana Peramuna (SLPP) is rising from the ashes albeit at a slower than anticipated pace, while President Ranil Wickremesinghe’s United National Party (UNP) still commands only 1-2 percent of the vote, an SLPP legislator said.

MP S B Dissanayake, who is not a member of the cabinet of ministers headed by President Wickremesinghe, told reporters on Thursday December 07 that support for any major political party of the island nation is on a downward trend while the SLPP alone is gaining ground.

An independent poll by the Institute for Health Policy (IHP) however shows that this is decidedly not the case. Polling data for October showed that the leftist National People’s Power (NPP) had enjoyed support from 40 percent of likely voters, having dipped 2 percent from September, while the main opposition the Samagi Jana Balawegaya (SJB) stood at 26 percent, increasing four percent from 22 percent in September. President Ranil Wickremesinghe’s UNP’s support decreased marginally to 11 percent in October from September’s 13 percent. The SLPP also saw a decrease to 5 percent from the previous month’s 8 percent.

“You can’t gamble with elections. The election must be held. We always say electrons must be held. The presidential election must be held next year. There is no alternative,” said Dissanayake.

“Parliamentary elections can be called if needed. But that’s not how it is with the presidential election. Nominations for that will have to be called by September, October next year,” he added.

Asked by a reporter if the SLPP is ready for elections, Dissanayake acknowledged that support for his party had eroded, to nothing.

“We crashed to zero. We were turned to ashes. But we will rise from those ashes. We’re not where we thought we were. The 6.9 million [votes received at the 2019 presidential election] no longer applies. We’re at about half of that. But we’re rising, like this,” he said, gesturing upwards.

“As other major parties go in the opposite direction, we’re rising slowly. But the UNP is not. It’s still on the ground, and still at 1 to 2 percent,” he claimed.

“The SLFP is there too. Those who left us are the same. Even together they cannot form 1 percent. But we’re climbing,” he said. (Colombo/Dec07/2023)

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Sri Lanka president appoints main opposition MP advisor

ECONOMYNEXT – Sri Lanka President Ranil Wickremesinghe has appointed MP Vadivel Suresh as a Senior Advisor aimed at “fostering the integration of Hill Country Tamils into Sri Lankan society”, the president’s office said.

A statement from the President’s Media Divison (PMD) said Suresh’s “pivotal role will centre around overseeing the comprehensive integration of Hill Country Tamils, particularly focusing on the districts of Badulla, Nuwara Eliya and Rathnapura”.

“The Senior Advisor will play a key role in coordinating various initiatives related to the welfare of Plantation Companies, the promotion of women, safeguarding children, addressing disparities in Tamil schools and upgrading the delivery of health services,” the statement said.

In May this year, Suresh, who represents the main opposition Samagi Jana Balawegaya (SJB) in parliament and also serves as the general secretary of the Lanka Jathika Estate Workers’ Union, made headlines when he issued an ultimatum to opposition and SJB leader Sajith Premadasa, demanding an apology for a perceived slight on the Indian-origin Tamil community that Suresh represents. He also spoke favourably of President Wickremesinghe, hinting at a possible cross over.

Sri Lanka’s Indian-origin Tamils, most of whom have historically worked in the plantation sector and live in dire conditions on wages widely considered unacceptably low. Speaking at a May Day rally, the Badulla district MP said Premadasa must apologise to the estate Tamils for allegedly snubbing them at an event in Madulsima that he failed to attend.

“I would like to say to our leader, sir, do not take us for granted,” said Suresh.

“If you need us to stay with you, come right now to Madulsima and apologise to my people and then we shall restart our journey. Otherwise I won’t be part of that journey. There will be no Vadivel Suresh. If you don’t apologise to my people, I won’t be with the SJB,” he said.

Making matters worse, the MP also expressed a willingness to join President Wickremesinghe if he was able to raise the daily wage of plantation workers and resolve their grievances. He also said the president has been successful in containing the disruptions caused by the currency crisis.

“On this May Day, we say to both the opposition leader and the president, I and my people would join hands with a leader that worked to increase [estate workers’] wages and give them [access to the Samurdhi welfare scheme] and include them in national policy,” he said. (Colombo/Dec07/2023)

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