ECONOMYNEXT – Sri Lanka will see the worst economic contraction in its history, Central Bank Governor Nandalal Weerasinge said as the country reeled from a currency collapse from 200 to 370 to the US dollar and interest rates corrected above 20 percent.
Sri Lanka is going through severe fuel shortages and power cuts after the credibility of a soft-peg was broken by mis-targeted interest rates in the course of targeting an output gap (printing money to boost growth) under Keynesian ideology.
“In our expectations the economy will contract at the highest rate than in any other year in history,” Governor Weerasinghe said in Colombo addressing the Press Club of the Sri Lanka Press Institute.
“We cannot make normal imports for the next three to six months. Industries are saying there are no raw material.”
Sri Lanka’s economy contracted 3.6 percent in 2020 amid a Coronavirus crisis and it also contracted 1.5 percent in 2001, after a soft-peg crisis amid a civil war.
The latest failure of the unstable peg with the US dollar came after the central bank printed over two trillion rupees over two years to mis-target interest rates leading to a steep collapse of the currency and a correction of the interest rates back to around 20 to 25 percent.
The economic crisis has also spilled into a political crisis and social unrest Governor Weerasinghe said.
The rupee’s 2022 fall to 380 to the US dollar from 200 to the dollar in the worst currency crisis created by the soft-pegged central bank in its 72 year old history.
The money printing central bank created its first economic crisis and output shock in 1953 bringing down growth to 0.7 percent after triggering a now famous ‘hartal’.
An exchange control was also enacted in 1952 as the printed money from the newly set up central bank scrambled to go out, in a phenomenon that was repeated multiple times over the next 70 years and dragged the country into 16 IMF programs.
The unstable central bank was set up by US money doctor in 1950 in the style of Argentina’ BCRA, abolishing a Currency Board that had kept the country stable through two World Wars and a Great Depression, where money printing above the external anchor was outlawed.
Among the worst recorded crises in the country include the 1948 uprising against the then colonial administration which took place after the British railway bubble burst (also known as the Commercial Crisis of 1847), commodity prices fell and the then Colonial government upped taxes. However there is no information on the economic contraction in that year.
In 1848 there were uprisings in many countries as the gold linked bubble burst (Revolutions of 1848).
It was known as the Springtime of Peoples, where monarchs were driven out and constitutional restraint established. (Further reading: 1848, the European People’s Spring)
Sri Lanka’s citizens burnt the houses and property of the elected ruling class on May 09, after the the unstable peg collapsed in a botched float where interest rates were not allowed to go up before the float and a surrender rule pushed the rupee down.
Interest rates were allowed to go up after Governor Weerasinghe was appointed and the economy is now slowing and the headlong crash of the rupee peg has slowed.
There is an attempt to strengthen the constitution to restrain the powers of the rulers.
However the soft-pegged central bank which prints money and makes outflows exceed inflows and beaks the peg keeping rates artificially low is likely to get more ‘flexibility’ through a draft constitution (Monetary Law) giving a committee more independence to conduct ‘flexible policy’ rather than restraining the rate setting Board.(Colombo/May23/2022)