Sri Lanka IMF program sets inflation ceiling as key target

ECONOMYNEXT – Sri Lanka’s Central Bank has been given an inflation ceiling as a key target for the first time in the deal with the International Monetary Fund as the country attempts to emerge from the its latest balance of payments crisis.

Under a ‘monetary policy consultation clause’, the program will be suspended if inflation reaches 8.2 percent by the year end, indicating that it has the status similar to a performance criteria.

If the Central Bank generates inflation of over 6.7 percent to hurt the poor by end-2016, it has to consult with IMF staff and provide explanations.

If the Central Bank inflates the economy by 8.2 percent to impoverish the people as measured by Colombo Consumer Price Index by end-2016, the program will be temporarily suspended until a consultation is completed with the IMF’s executive board and policy is tightened.

The ‘monetary policy consultation clause’ is an experiment started a few years ago by the IMF in place of having tight reserve money targets and a ceiling on domestic assets of the Central Bank (printed money stock).

IMF moved to the consultation clause for countries with an ‘evolving’ monetary policy framework.

However, at a ceiling of 8.2 percent, it still give substantial discretion for the central bank to impoverish the people and generate monetary instability.

The Central Bank created the current balance of payment crisis with inflation of less than 5 percent as measured by the Colombo Consumer Price Index at a time when the U.S. was tightening policy and global inflation was low.

Long-time watchers of Sri Lanka’s monetary authority say the 2012 crisis could have been avoided with a ceiling on net domestic assets of the Central Bank under the then program.

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Under the current three-year Extended Fund Facility, Sri Lanka is expected to move into a ‘flexible inflation targeting regime’, another experimental monetary regime that may also give substantial discretion for the Central Bank to generate monetary instability. Under flexible arrangements, a central bank may have dual mandates, which lead authorities astray.

The IMF had moved to the ‘monetary policy consultation clause’ partly because it was seen that some countries had managed to keep inflation low despite missing reserve money and domestic assets ceilings especially when inflation had been low to start with. Unlike in the 1970s, global inflation had been generally low from the 1980s, and the U.S. Fed and the Bank of England learned to generate lower inflation.

The Central Bank, which has a monopoly on printing money, is the only agency that can generate high inflation in a country.

No government can keep prices down with subsidies or other measures, and if such subsidies are financed by printing money, inflation and balance of payments trouble will follow, as has happened in Sri Lanka from 1952, within a year of the creation of the Central Bank. (Colombo/June14/2016)

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