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Sri Lanka inflation spike in January not demand-driven: CB Governor

ECONOMYNEXT – Sri Lanka’s spike in 12-month inflation to 5.5 percent January 2017 was due to statistical and ‘supply’ issues, and was not driven by demand, which can be corrected by higher interest rates, Central Bank Governor Indrajit Coomaraswamy said.

He said the Central Bank watched the current account deficit of the balance of payments and inflation.

There was a widening of the trade deficit due to the import of a dredger and 12-month inflation in the capital rose to 5.5 percent in January from 4.5 percent in December.

Meanwhile core-inflation, a controversial measure without food and fuel which usually understates price rises and is used Sri Lanka’s central bank and other central banks not to tighten policy rose to 7.0 percent in January from 5.8 percent in December after the index was re-based.

Before the rebasing core inflation was already at 6.3 percent but headline inflation was 4.1 percent. In the earlier index, alcohol was not included in a transparent ruse understate inflation.

Coomaraswamy said the re-basing reduced the food component to 30 percent of the index and non-foods was not 70 percent.

He said headline inflation was still within a target band agreed with the International Monetary Fund.

"Core inflation has gone up. We need to examine what caused it," he told reporters in a February 08 media conference.  "If you look at the delta – the increase in core inflation – almost 50 percent of it is explained by education."

He said it was probably caused by a delayed effect of value added taxes which had affected school fees, which are charged at the beginning of the year.

"If you break down the causes of the uptick in inflation, it comes down to that and some supply disruptions related to the drought," Coomaraswamy said.





"So the interest rate is an instrument that is useful in influencing demand. So it is not really demand-side pressure that has pushed up the inflation, particularly core-inflation."

"As a result it would not really be appropriate to increase interest rates on the basis of the increase in core inflation."

In Sri Lanka policy rates only partly determines whether monetary conditions are loose or right as he Central Bank creates money by massive bouts of sudden money printing or by intervening in forex markets to buy dollars (unsterilized purchases) and maintain a peg.

It also creates money after selling dollars to maintain its policy rates, generating excess credit and balance of payments troubles (sterilized forex sales).

In the first week of January the Central Bank created tens of billions of rupees for the Treasury to pay back a maturing rupee bond. The Central Bank, under Coomaraswamy however mopped up most of the money in the ensuing weeks.

Though random shocks and one-off events can generate temporary changes in a price index, all inflation is monetary.

In Sri Lanka, due to the dollar peg, inflation comes from the Federal Reserve (imported inflation or deflation), and Sri Lanka’s loose policy or currency depreciation adds to it.

I the past three or four months, oil and liquefied petroleum gas prices have risen steeply but they are not yet seen in the price index. Instead utilities are funding the costs with credit or a lowering from margins.

Analysts say it is dangerous to attribute inflation to non-monetary or ‘cost-push’ factors as such central banks will end up with higher inflation, bigger bubbles and currency troubles.

Critic also say that Sri Lanka also has a tendency to believe not just in cost-push inflation, but that an unspecified portion of inflation can be caused by costs and another portion by demand, which the main proponents of the cost-push inflation themselves did not claim.

Attributing cost-push factors to inflation ranges from Sir James Steuart in 1767 (Inquiry into the Principles of Political Oeconomy) and the ‘anti-bullionists (Real Bills Doctrine) in the early 1800s during the Napoleonic wars and a crop failure.

Thomas Tooke revived it in the Banking-School Currency School debate. He argued among other things that rising interest rates caused business costs to rise thereby causing ‘inflation’.

Many of the modern cost-push inflation theories including wage-spiral inflation and new ones such as OPEC driven inflation, came into fashion in the 1970s, after the US dollar went off the gold standard in a fit of money printing creating the so-called Great Inflation period. (Colombo/Feb20/2017 – Correted Headline and opening para – Sri Lanka inflation spike in January not demand-driven: CB Governor )

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