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Tuesday April 23rd, 2024

Sri Lanka should protest the 7-pct annual inflation target, not a 3-pct VAT hike

ANCHOR: The external monetary anchor used by the Maldives is far from perfect, but is far far better than Sri Lanka’s 7-pct domestic inflation target.

ECONOMYNEXT – Sri Lanka’s politicians are protesting a once in a lifetime valued added tax of 3 as well as the imposition of VAT on some new items, but far more damaging to the poor is the deadly power given to macroeconomists to generate 5 to 7 percent inflation every year.

Sri Lanka’s macro-economists had inveigled President Ranil Wickremesinghe to handed them the power to conduct monetary policy (read print money) and generate inflation of 5 percent a year with room to push up price rises to 7 percent.

Related Sri Lanka central bank gets political nod to create up to 7-pct inflation

Legislators had already been misled by inflationists into passing the new IMF backed monetary law to target potential output (print money for growth) in the style of John Law, so positive inflation targeting was a piece of cake.

If the IMF knew how to actually draw up a monetary law to provide stability, with a proper operational framework, it would go out of business in two Fed cycles with no customers to bailout.

The Macro-inflationists

Positive inflation targeting denies private sector (capitalist) productivity growth to the people, making them mis-trust private sector led activity, liberal democracy and bring nationalists and other fringe elements to power in the high inflation period or the stabilization that follows.

And whenever there is high productivity growth after a period of stability, central banks fire an asset asset price bubble in trying to reverse it, as happened in the 2008 financial crisis/housing bubble.

If the power of ‘monetary policy’ (injecting liquidity to inflate bank reserves) was taken away from macro-economists this country will have a stable currency and inflation between 1 and 3 percent.

If Sri Lankans have been misled by macro-economist into an inferiority complex and;

a) cannot imagine that they deserve an inflation rate better than Americans, the Swiss or the British,

b) or they do not know that before 1977 Sri Lanka also had the same inflation as Western nations,

c) or cannot relate to Dubai or Saudi Arabia (an even better fully orthodox fixed exchange rate regime existed during British rule),

d) at least they would be able to relate to the Maldives or Cambodia.

The monarchies in GCC countries have remained due to the stability coming from the fairly hardened peg, unlike Iran’s Shah (and indeed Prince Norodom Sihanouk) who was driven out with the help of inflation around the same time.

In the late 1960s when Sri Lanka first started to go to the IMF was when the likes of Paul Samuelson started to corrupt US policy in the heyday of the Phillips Curve, even Malaysia which had a good monetary authority which worked almost like a currency board, saw a second communist uprising.

To give stability to the poor and prevent their flight to countries with monetary stability to seek jobs, the inflationist and interventionist ideology spread by macro-economists and the International Monetary Fund since 1978 in particular has to be defeated.

Sri Lanka’s new monetary law the agreement with Ranil Wickremesinghe shows that the Phillip’s Curve is alive and well, albeit under another label.

Third Rate Discriminatory Monetary Anchors

Before 1978, the IMF did not discriminate between rich countries and less rich countries allowing nations like Sri Lanka to have worse monetary anchors than Western nations.

The big challenge is to defeat the ideology of Progressive Saltwaterism and the relentless drive by the IMF to give central bank powers more and more powers to conduct ‘monetary policy’, essentially tools to print money to mis-target rates for interventionist purposes.

There are several ways to absolutely block the macro-economists from triggering external instability. The easiest is currency competition or dollarization, the other is a currency board.

Friedrich Hayek called currency competition the denationalization of money, but it is actually the emasculation of the Harvard – Cambridge macro-economics and to take away their powers to push up inflation, depreciate the currency and otherwise create monetary instability.

The advantage of monetary stability to politicians would be that they can remain in power for multiple terms and do reforms to boost growth, continuously.

The advantage to the people would be that interest rates would fall to around 5 percent and they can also be free of exchange controls.

The stability will also bring in foreign investors and real incomes would rise over time.

No good budgets with bad money

Bad money, in addition to destroying the finances of individuals, also destroys governments budgets. There can be no good budgets with bad money.

Under dollarization or a currency board, budget deficits would fall and the debt to GDP ratio would be low, at 50 percent or below as is seen elswhere, from GCC countries to Bulgaria to Cambodia to Hong Kong to Pananam.

Without central banks, it is difficult to borrow heavily and the need to give subsidies also goes away. Without a depreciating currency, domestic savings are good enough for investment and the need to borrow abroad is less.

Cambodia had very high debt as the currency collapsed in 1989 amid a coup and the country market-dollarized without any outside help.

The coup leader Hun Sen, was a former associate of Polpot (who abolished money after high inflation).

The country is now growing at 5 to 6 percent a year (Cambodia grew faster in the initial years after dollarization) getting several billion dollars of FDI and is moving from apparel into electronic items including solar panels, riding the renewable energy wave amid the stability brought by dollarization and currency competition.

As a result of dollarization (or currency competition) the central bank cannot conduct monetary policy like in Sri Lanka to (print money to cut rates and generate high inflation and depreciation) effectively.

The IMF remains relentlessly opposed to the status quo and stability and is trying to de-dollarize and give a few unelected economic bureaucrats the power to destabilize the nation again.

“Cambodia has experienced rapid growth over the past decade, outpacing many regional peers. Growth was driven by industrialization, increased foreign direct investment, and a surge in exports, particularly in labor-intensive manufacturing,:” the IMF said in its latest staff report on the country issued in January 2024.

“The Cambodian economy is continuing its recovery from the pandemic, with a GDP growth of 5.2 percent in 2022, driven primarily by manufacturing exports, especially in garments and electronics. Tourism saw a continued rebound in 2023, reaching close to 80 percent of pre-pandemic tourist arrival levels by September 2023.”

“Inflation, after dropping significantly in H1 2023, has since rebounded,” the IMF claims.

The IMF’s ‘rebounded’ inflation is a little over 3.0 percent.
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“The fiscal deficit is projected to widen in 2023 due to temporary increases in spending and is expected to decrease in 2024,” the agency also claimed.

However, budget deficits are also around 3 to 4 percent. The debt to GDP ratio is 34 percent, a trend that is common in countries with currency boards or are dollarized where monetary policy is constrained. Currency unions with liquidity tools do not have the same benefit.

The IMF however wants to give more power for ‘monetary policy and enhance “monetary
transmission and support de-dollarization” by “modernizing” monetary and FX policy operations.

“Establish an effective interest rate corridor and develop an accurate liquidity forecasting framework. Strengthen the market determination of exchange rates and improve operation of FX intervention procedures.”

The entire benefit and stability Cambodia got from the denial of monetary and fx policy discretion to economic bureaucrats from 1990 will be lost if Cambodia become increasingly de-dollarized and its monetary policy is ‘modernized’ based on various inflationist fads developed in the US and elsewhere and transplanted by the IMF as potential output targeting was planted in Sri Lanka eventually taking a country without a war to default.

Eventually Cambodia may return to its 1970s and 1980s fate or to the fate its unfortunate neighbor Laos, where domestic and IMF bureaucrats have full ‘monetary and fx policy’ discretion and is a basket case.

Then China, a top lender to Cambodia, will be blamed for default.

Unlike an Inflation Index, a Nominal Exchange Rate Target Cannot be Fudged

By constraining monetary policy discretion of bureaucrats and forcing them to maintain the exchange rate – which is a transparent price unlike inflation indices or the REER and cannot be fudged by changing the base – stability can be given for growth and prosperity.

Maldives also has low inflation around 1 to 3 percent without macro-economists to do complicated ‘monetary policy’.

The Maldives Monetary Authority however does print money from time to time and get into trouble. When the peg breaks, inflation soars.

Any technical assistance from the IMF to engage in more aggressive monetary policy would land the country in default.

Maldives actually has borrowed too much, from China and also some of its Middle Eastern friends during about two decades of loose money starting from the Greenspan – Bernanke bubble when easy dollar borrowings were possible.

What policy-makers and politicians have to understand is that denying monetary stability by various in-vogue third rate monetary regimes is not a foundation to base a policy framework.

But from 1950 onwards that is what happened to this country.

To be fair, current Central Bank Governor Nandalal Weerasinghe is doing a good job.

But the relaxation of standing facilities, which do not have a penal rate in Sri Lanka unlike in stable countries, is a key tool for banks to overtrade and goes against prudent policy. It could be the first step in the next default, as targeting call money rates in the middle of the corridor and narrowing the policy corridor was in the current default.

However, the way to achieve stability is not to depend on personalities but to constrain discretionary policy by law.

That is to either have a very low inflation target like 2 percent which has been mostly successful elsewhere, or a hard peg or currency competition through dollarization.

All of these have worked. Where had a 7 percent inflation target worked? This country ran into a default without a war with the room given for open market operations and outright purchases with a 5 percent inflation target.

A 2-pct Target is Better, But Also Has Problems

This columnist is fully supportive of a 2 percent inflation target, but it is not as good as earlier anchors of the classical period or what is advocated by Austrian economists, which drove the policies of Germany after World War II, and made it a stable export powerhouse.

Now Germany is also in trouble with the ECB.

It must be noted that the constant price level, which also denied private sector productivity growth to the poor, was advocated by the Chicago school, at a time when post-Keynesian policy was in full swing in the 1960s, with completely un-anchored policy, leading to the eventual collapse of the gold standard.

Austrian economists warned that even a constant price level would also lead to a boom and bust scenario if there was a capitalist productivity boom, coming after a period of stability, which allows research and development.

“The long-run tendency of the free market economy, unhampered by monetary expansion, is a gently falling price level, falling as the productivity and output of goods and services continually increase,” explained US economist Murray Rothbard in 1971 in the dying days of the Bretton Woods.

“The Austrian policy of refraining at all times from monetary inflation would allow this tendency of the free market its head and thereby remove the disruptions of the business cycle.

“The Chicago goal of a constant price level, which can be achieved only by a continual expansion of money and credit, would, as in the 1920s, unwittingly generate the cycle of boom and bust that has proved so destructive for the past two centuries.

This was graphically demonstrated after Ben Bernanke misled Alan Greenspan to try and reverse private sector productivity growth from 2000, and kept rates near zero, firing an 8-year Fed cycle (also enabled by core-inflation which discounted commodity prices), leading to the housing bubble.

In the Great Moderation (Volcker/Greenspan) period, gold prices fell to 800 to 484 dollars, free trade was accepted, East Asian poverty fell under fixed exchange rates and largely deflationary policy (reserve collections).

In a reserve collecting peg forex troubles emerge before the asset bubble.

The low US interest rates in the run up to 2008 bust as well as quantity easing that followed is one reason for bondholders and China to finance unstable countries with dollar credits. (Sri Lanka’s collapse in new sovereign default wave is not really China’s fault: Bellwether)

In the wake of these monetary blunders not only is Sri Lanka in trouble, but also the US, showing how bad money leads to bad budgets once again.

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Iran President to open Sri Lanka $514mn irrigation, hydro power project

MULTIPURPOSE: Uma Oya multipurpose development project is the largest since the end of the Mahaweli projects.

ECONOMYNEXT – Iran President Seyyed Ebrahim Raisi will inaugurate an irrigation and hydropower project that was designed and built by Iranian engineering firm and was also initially financed before international sanctions hit the project.

The Uma Oya (River) project will irrigate 4,500 acres of new agricultural land, generate 290 Gigawatt hours of electricity and also provide drinking water, a government statement said.

Sri Lanka had awarded an engineering, procurement, construction (EPC) to Iran’s FARAB engineering group to design and construct the 514 million dollar multipurpose project in 2010.

The project was funded until 2013 with a million US dollar credit from the Export Development Bank of Iran but international sanctions prevented the country from continuing financing, a government statement said.

The project continued with funding from Sri Lanka. Sri Lanka had since repaid 19.3 million dollars of the credit and 35.2 million remains outstanding.

The Uma Oya project has a 120MW of hydro power generators, which can generate 290 Giga Watt hours of energy.

Each year 145 million cubic metres of water will be taken from Uma Oya to the Kirindi Oya river valley after generating electricity in an underground power station.

It will irrigate 1,500 hectares of existing agricultural and 4,500 hectares of new land in the Moneragala district, where crops can be cultivated in both the Maha and Yala seasons.

About 39 million cubic meters of water will be used for drinking and industrial purposes.

Two reservoirs built at Dyraaba and Puhulpola in Uma Oya basin is connected by a 3.98 kilometre conveyance tunnel and water is taken through a 15.2 kilomtre headrace tunnel to an underground power station. A tailrace tunnel takes water from the power station to the Kirindi Oya basin.

The project was originally expected to be completed in 2015, but due to financing delays and later water leaking into the headrace tunnel and the Covid pandemic had delayed it. The project completion date was extended to March 31, 2024 and defect liability date to March 31, 2025.

(Colombo/April23/2024 – CORRECTED Iran President Seyyed Ebrahim Raisi will inaugurate an irrigation and hydropower project that was designed and built by Iranian engineering firm.)

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Sri Lanka state oligopoly allowed to import some black gram

ECONOMYNEXT – Sri Lanka has allowed the import of some black gram, by three state agencies, according to a gazette notice issued under the hand of President Ranil Wickremesinghe.

Import licenses will be given for 2,000 metric tonnes of the seed classified under HS Code 7312.31.22 and 29.

Sri Lanka State Trading Corporation, National Food Promotion Board and Sri Lanka Hadabima Authority is to be given import licenses.

Traders have resorted to smuggling some types of black gram (ulundu) mis classified as chick peas, to get over high taxes and import restrictions.

Tamil legislators have also protested the import controls, which they go into several key ethnic foods they consume. (Colombo/Apr23/2024)

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Sri Lanka Foreign Ministry consular division shifted to Battaramulla

ECONOMYNEXT – Sri Lanka’s Foreign Ministry said it consular division would be shifted to the Suhurupaya building in Subuthipura, Battaramulla from May 02, 2024.

Document authentication services provided by the Consular Affairs Division in Colombo will be suspended on 29 and 30 April 2024 held transfer the Electronic Document Authentication System (e-DAS) to the new premises at Suhurupaya.

Urgent applications for authentication to the Consular Division in Colombo, or any Regional Consular Offices by 4.15 pm on 26 April 2024, the Foreign Ministry said.

Regional Consular Offices in Jaffna, Trincomalee, Kurunegala, Kandy and Matara will remain open to accept applications.

Authenticated documents will be delivered to the applicants only on Thursday, 02 May 2024.

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