Public sector pay rise and its dangers

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Some professionals, for the proposed new ‘2022 Budget’, to transform from ‘development’ to ‘welfare’, recommended by Premier Ranil Wickremesinghe when he was in Opposition, have advised the Government to increase public sector salaries by a record Rs 20,000 to tide over record high inflation and cost of living (CoL).

But the danger in such a salary hike is that such an increase in turn may lead to ‘demand-pull’ inflationary pressure, thereby negating the very purpose of such increments.

Three chief causes for high inflation and CoL are money printing (MP), also, directly associated with such proposed hikes; ‘cost-push’ inflationary pressure emanating from a weak rupee as Sri Lanka is an import-dependent economy and recently, the lack of fuel, a contributory factor for a US dollar vacuum to import fuel, thereby precluding domestic agriculture produce from entering the local market, hence, causing artificial shortages and therewith price pressure.

Nonetheless, Central Bank of Sri Lanka (CBSL) Governor Dr. Nandalal Weerasinghe, speaking to the media from CBSL Headquarters, Colombo on Friday, said that CBSL will continue to use MP as a tool to contain high interest rates. A main reason for CBSL not wanting to raise rates ‘further’, after recently increasing policy rates by a record seven per cent, is the pressure such hikes will cause on the financial sector’s non-performing asset ratios, thereby threatening its stability.

Further, Weerasinghe defended CBSL’s proposed actions, possible, or real, of rolling out MP, by purchasing Treasury
(T) Bills in the event, in the usual weekly T-Bill auctions, the market was asking for ‘higher’ rates. He said that inflationary pressure was not caused by MP, but by a weak rupee coupled with other cost-push factors. The ‘other’ cost-push factors which the CBSL Governor referred to were high commodity prices, among which a significant feature was high crude oil prices led by the Russian-Ukrainian war.

Meanwhile, nationwide inflation hit its highest peak of 33.80 per cent last month, breaking a near 42-year record, Census and Statistics Department data, released yesterday, showed. The previous record was 32.50 per cent established in August 1980.

‘August 1980 inflation’ was led by expenditure incurred in relation to the multibillion rupee Accelerated Mahaweli Development Project, while current inflation is led by sky high food inflation, driven by a previous Government policy of banning chemical fertiliser for seven months, from April 2021 to November 2021, which have scarred harvests, led by the Maha 2021/22 rice harvests, coupled with US dollar scarcity which has all but grinded food transport domestically to a halt.

Subsequently food inflation hit a record high 45.1 per cent last month, beating its previous record of 32.1 per cent established nearly 14 years ago in August 2008, where, globally, that took place on the eve of the Global Financial Crisis and the Great recession which came to a head a month later in September 2008 with the collapse of the US-based financial services company Lehman Brothers and  domestically, the Government’s war with the LTTE which had reached a crucial point, then.

Non food inflation too, broke a near 14-year-old record, accelerating to 23.9 per cent last month, beating its previous record of 16.8 per cent established in November 2008.

A pay hike under the circumstances for public servants is justifiable, but the question is whether a proposed pay hike of a Rs 20,000 magnitude will drive inflation further, or not? Chances are that it will.

Therefore, while allowing for a reasonable pay hike, the Government also simultaneously needs to address supply side constraints, beginning with the lack of fuel which is driving food inflation due to the inability to transport agriculture produce to the market.

A key driver of inflation is the lack of US dollars. An adequate amount of dollars in the market will strengthen the rupee and address cost-push inflationary pressure. Lack of dollars may be addressed by remedying concerns of the international community in respect of human rights and the rule of law.

The ball is in the court of President Nandasena Gotabaya Rajapaksa and his Premier Wickremesinghe to deliver.