The Dire Need to Redress a Bleak Economic Outlook

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This column analyses inflation in Sri Lanka in 2022. Inflation, measured by the Consumer Price Index (CPI) reflects the annual percentage change in the cost to the average consumer of acquiring a basket of goods that may be fixed or changed at specific time periods, for example, annually. The standard inflation figure is considered to be 2% +- 1% CPI. Hyperinflation refers to extremely acute inflation over a period of time. In general, it can be concluded that a country is experiencing hyperinflation when the prices of ordinary goods are rising in an excessive manner over a long period of time. High inflation increases the prices of all essential commodities and is thus directly connected to the increase in the cost of living. This puts extreme pressure on Sri Lankan households which struggle to meet the basic costs of living. Pressure is highest on low-income families especially in the rural areas of the country, daily-wage earners, domestic-workers and other low-income consumer groups.

A historic analysis of the inflation figure in Sri Lanka

By the end of July 2022, Colombo’s food inflation surpassed 90% and the overall inflation reached 60.8%. According to the Trading economicswebsite, Sri Lanka’s annual inflation reached an all-time high, 39.1% in May from 29.8% in the preceding month. This was the highest inflation rate recorded ever in Sri Lankan history until the July 2022 figure and the sixth consecutive double-digit growth in consumer prices as prices continued to escalate for both food and non-food products. On a monthly basis, consumer prices increased by 8.3% in May from a 9.3% rise in April.

In May 2022, Sri Lanka’s annual inflation climbed to 15.1% compared to February 2022, up from 14.2 % in the previous month. This was the highest recorded inflation rate since November 2008 and the third consecutive double-digit growth in consumer prices as they continued to rise for both food and non-food products.

Sri Lanka inflation rate for 2020 was 6.15%, a 2.63% increase from 2019

Sri Lanka inflation rate for 2019 was 3.53%, a 1.39% increase from 2018

Sri Lanka inflation rate for 2018 was 2.14%, a 5.57% decline from 2017

Sri Lanka inflation rate for 2017 was 7.70%, a 3.75% increase from 2016.

Let us first start by examining the theory of inflation. The monetary theory of inflation asserts that money-supply growth is the cause of inflation. Faster money-supply growth causes faster inflation. In particular, 1% faster money-supply growth causes 1% more inflation. If other factors are constant, the price level is proportional to the money supply. Doubling the money supply would double prices. According to the Exogenous Theory of Money Supply, the money supply is exogenous, set by the Central Bank (CB). The CB has the power to make the money supply larger or smaller and to make the money-supply growth rate larger or smaller.

The problem with high inflation

Inflation has knock-on effects on consumers and the overall economy. Firstly, inflation reduces the buying power of the consumer. An overall increase in prices over time, reduces the buying power of consumers, since a particular sum of money will be less valuable and will purchase a smaller basket of goods. Consequently, high inflation leads to an erosion in the value of money which is directly connected to an erosion in buying power of the consumer. Secondly, high inflation has an excessive effect on lower-income households and individuals. Lower-income households and individuals traditionally spend a higher portion of their limited income on essential goods than higher-income households and individuals. Thus, they have less of a safety-net against the loss of buying power resulting from inflation. Lower-income wage earners in developing economies such as Sri Lanka, spend a greater portion of their monthly or weekly salaries on essential commodities, such as food and clothing, items that are non substitutable when prices increase- these are essential items that must be purchased regardless of high inflation. It is important to understand that some inflation is necessary and can be a sign of a healthy economy. As noted earlier in this research article 2% inflation is considered a standard figure and is not considered dangerous. The issue is when inflation rises above this figure. Thus 2% +- 1% inflation is largely ‘white noise’ which can be ignored. However, when inflation begins to accelerate sharply, as it has, over the last three quarters, predictions about future inflation figures will begin to rise. As these predictions rise, employees start demanding higher wages and employers pass on this increasing cost of production in the form of higher prices. This creates a phenomenon which Sri Lanka is currently experiencing.

Conclusion

In conclusion this columnindicates a bleak picture in relation to Sri Lanka’s economic and development capabilities. The conclusion this column makes is a very, very pessimistic one. Sri Lanka’s inflation figures are just unmanageable and have reached hyper-inflation levels. This is extremely dangerous for any economy and requires immediate, serious remedial action. Germany experienced five years of crippling inflation after World War 1. In the US rising inflation figures in the 1970s, lifted annual inflation figures above 13% by 1980. Sri Lanka is currently experiencing its share of hyper-inflation which is having knock-on effects on other areas of the economy such as unemployment, production and the ‘balance of payments’ figure.  Sri Lanka’s ‘inflation catastrophe’ requires urgent political intervention by the political leadership to alter the interest rates and manipulate monetary policy in order to‘artificially’ correct the inflation figure in the short-run to long-run. If this is not done, it risks plunging the Sri Lankan economy and its 22 million population into an even graver economic, political and humanitarian crisis than it is in.

The writer can be contacted at [email protected]

BY Sachin Parathalingam