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Serving Sri Lanka

This web log is a news and views blog. The primary aim is to provide an avenue for the expression and collection of ideas on sustainable, fair, and just, grassroot level development. Some of the topics that the blog will specifically address are: poverty reduction, rural development, educational issues, social empowerment, post-Tsunami relief and reconstruction, livelihood development, environmental conservation and bio-diversity. 

Wednesday, October 19, 2005

How to lose the cost of living battle thru’ incompetence

Daily Mirror: 11/10/2005" By Harsha de Silva, Ph.D

The bottom line is there is no validity in the Samaraweera argument that it is not possible to control cost of living increases when the oil prices are increasing. In fact inflation measured on a point-to-point basis came down over the last few months even though oil prices continued to increase. And that was thanks to the price revisions at the pump and the Central Bank raising interest rates to control demand pull inflationary pressure after heavy criticism from many quarters. This reminds me of some of the television talk shows in which the JVP freshmen appeared in 2004. I remember them asking why we needed a government if it could not hold rising consumer prices just because oil prices were going up. They were right. They should ask themselves or the remnants of their Rata Perata regime that question.

Now that the dust has settled, perhaps it is time to get back to our regular column on economics. Discussions that originate from these columns go to show the importance of the subject in this election campaign. It is also interesting to note the space The Daily News allocates to taking swipes at me through their Kavanthissa’s Election Diary column. Anyway, let’s get down to business.

Rata Perata government cannot be held responsible for soaring inflation?
Today we don’t have to refer to the controversial Giddens because the question raised by Mangala Samaraweera, the spokesman for the Hon. Prime Minister’s presidential campaign at a recent news conference is straight forward. That is, how can anyone intend to control cost of living escalations despite soaring world oil prices? According to news reports, spokesman Samaraweera had said “Ranil’s manifesto will not be accepted by the people. This has been prepared to fool and mislead the people. Although he talks about bringing down the cost of living Wickremesinghe has no idea about the position with regard oil prices in the world market."The central argument is that as long as oil prices are increasing, cost of living increases cannot be controlled. It is ironic that know-it-alls like Samaraweera can make such uninformed statements. But on the other hand, what economics does he know? I think the starting point should be to look around us. Given below are some selected references on inflation from our region. Now, is Samaraweera saying that countries besides Sri Lanka somehow have not been affected by rising oil prices? What a joke? Since the answer is obvious, there must be something else these other countries did that allowed them to control rising cost of living. Note that even countries with difficulties like Philippines, Indonesia and Vietnam have not let inflation move up to half of what our levels are.

We keep company with Congo, Malawi and Ukraine at 12.5% inflation
That inflation in Sri Lanka is an outlier is true not just in developing Asia, but the entire world. According to the latest IMF statistics only 16 out of all countries in the world have higher inflation forecasts than Sri Lanka for 2005. Perhaps it’s worth finding out the company we keep. They are Angola, Congo, Erithria, Ghana, Guinea, Malawi, Mauritania, Nigeria and Zambia in the African region; Serbia and Montenegro in the Central and Eastern European region; Ukraine and Uzbekistan in the CIS region; Myanmar in the Developing Asian region; Yemen in the Middle East region and finally Haiti and Venezuela in the Western Hemisphere! This is a miserable indictment on us; please feel free to read more at www.imf.org/external/pubs/ft/weo/2005/01.

Fuel price pass-throughs are far less inflationary
Economics, as I have mentioned in these columns before, is more complex than what meets the eye; specially the ignorant politician’s eye. This whole cost of living and inflation mess we are in today is something we could have avoided if these politicians had let the professionals; both at the Treasury and the Central Bank do their jobs. Looking at countries that have been successful in controlling inflation in the face of rising oil prices, it is clear that independence of officials is a common denominator.

The cardinal principle was to avoid widening the budget deficit to unsustainable levels through massive and untargeted fuel subsidies to keep pump prices unrealistically low. It has been shown that passing the adjustment to the user and employing alternative mechanisms to cushion the impact on those segments of the population who find it difficult to sustain price increases have worked much better in controlling economy wide cost of living problems. Evidence suggest that the inflationary impact of a fuel price pass through is much lower than when it is unsuccessfully ‘absorbed’ by the state until it is finally forced to give up the subsidy. The impact is not only on the domestic front but also on the external front with depleting foreign reserves and pressure on the currency. It’s really not difficult to see why this is the case. Let me explain it using Sri Lanka as an example.

Consequences of unintelligent policy
As oil prices kept increasing, the so called ‘pro poor’ Rata Perata Government kept pumping in more and more subsidies to maintain the prices at the pump; estimated to be in the region of LKR 20,000 million, until it was finally forced revise prices as inflation became unbearable. It should be noted that fuel subsidies are generally regressive, in that rich and upper middle class spend relatively more of their income on fuel than the poor and the lower middle class, therefore benefiting more from the subsidy. In any case, given the Government had no money to pay for the subsidies, or in other words to bridge the budget deficit caused by this huge unsustainable expense, it resorted to the most ‘anti poor’ policy any Government could ever undertake; it printed money. The results are evident. It deteriorated value of the currency, both inside and outside the country, causing immense burdens on people notwithstanding race, religion or place of origin. The worst affected are today unable to have food on the table and struggling to survive. Therefore it is no secret that cost of living has become a critical issue in the upcoming presidential election. The election, for the most part is one to select a leader with a vision to bring back a sense of dignity and three square meals on the tables of the masses of this country.

In this context it is humorous, yet sad, what Samaraweera’s presidential election campaign office has stated in a communiqué the other day through a spokesman who I wish not to bring in to this debate. According to the press the spokesman had refuted the claim made in Ranil Wickremasinghe's manifesto, stating the UNP will cease printing money and strengthen the rupee. He had said that Wickremesinghe had printed the highest amount of currency in the country's history and comparatively less had been printed by the Peoples Alliance.

The question is whether the gentleman is unaware of the facts or whether he is being deceitful in making such statements? Assuming the former, let me briefly explain to him and others in his shoes that printing money does not mean printing currency notes! This is the second time in one year that I have had to tutor these folks; first it was our now silent Darasiel (by the way, where is he?) when he attempted to deny printing money by saying he had not signed a single currency note. I thought we had made progress since then, but alas, these funny characters just keep popping up! In economics, what is referred to as printing money is the activity of the Treasury getting the Central Bank to purchase fresh government securities (Treasury Bills) in return for money that was thus far non existent. This is also called creating money, because only the Central Bank has the authority to create, or print money in this form. Once this money gets in to circulation through the Treasury and subsequently the banking system via payments to people for various goods, services or subsidies, the original amount printed gets multiplied by what is called the money multiplier, currently around 5, before finally settling in peoples wallets.

Open challenge
According to the Annual Report of the Central Bank for 2004, it’s holding of treasury bills increased from LKR 11.5 billion to LKR 74 billion during the year; a net money printing job of LKR 62.5 billion. I wish to point out to the Government spokesman that the same report for 2003 indicates that the Central Bank’s holding of treasury bills in fact reduced by LKR 29 billion in 2003 and LKR 18 billion in 2002 in the Ranil Wickremesinghe regime. Therefore, for anyone to say that the Rata Perata government printed less money than the previous one is an absolute and utter falsehood. I challenge any one in the Samaraweera team to prove me wrong! If not, I suggest that such lies not be repeated.

Fundamental untruths
The Hon. Prime Minister’s campaign office has mentioned further that the Rata Perata government had brought down inflation giving much relief to the people. This is absolute bunkum. Let us consider how our know-it-all politicians brought down inflation by forcing the Central Bank to print billions of rupees as explained earlier. On top of already existing supply push inflation pressure caused by high oil prices and the drought, it created demand pull inflation pressure; that is, too much money (printed money being much more than what was necessary to keep in tandem with the growth in the real economy) chasing too few goods. With this flooding of money in the economy combined with supply issues, the entire price structure started shifting upwards. Currently inflation measured by the annual average Colombo Consumer Price Index stands at 12.8 percent. In other words, rate of price increase of a typical basket of goods and services a family purchases is up by almost 13 percent since this time last year. In terms of domestic purchasing power, the value of the Sri Lanka rupee is 13 percent less than what it was a year ago. In contrast, inflation measured by the same yardstick was 14.2 percent in November 2001 just before the UNP assumed office and 3.7 percent in March 2004 just before it handed the reigns to the Rata Perata government.

Darasiel revisited
High inflation causes people from all walks of life ranging from farmers and fishermen to small business people to state and private sector workers and pensioners to become poorer. The group that is least affected is the rich; particularly those who have relatively less LKR denominated fixed income assets in their portfolios. Consider for example the millions of private sector workers who have contributed over decades to the EPF. They are seeing their capital erode because the so called pro-poor government has still not sufficiently adjusted rates paid to EPF investments upwards to account for high inflation rates which are yielding negative returns to the EPF holders. Same with small savers across the country who don’t know that the 5 percent they receive at the NSB is actually negative 8 percent in real terms! This high inflation rate regime combined with low deposit rates has turned Saradiel in to Darasiel whose Rata Perata policies are actually transferring wealth from the poor to the rich. Perhaps it might be good idea for the Prime Minister’s campaign office to invest LKR 200 to purchase a copy of the Annual Report of the Central Bank and study it before the next round of fiction is dished out by our powerful, yet embarrassingly ignorant duo of spokespeople.

Can inflation come down while oil prices go up?
Attempting to justify soaring inflation, Samaraweera had stated that during the past one year the world oil price rose by 177 per cent and that during the two years when Ranil Wickremesinghe was Prime Minister, they rose by only 14 percent. Again the facts do not support this position. According to the publicly available statistics of the US Department of Energy, the price of Light Sweet Crude was USD 18.54 per barrel on 6 December 2001 soon after Wickeremesinghe assumed office, and it was USD 37.14 on 8 April 2004 soon after the Rata Perata government was installed. That is an increase of 36.1 percent. However during this same period, rate of inflation measured by CCPI annual average (to be consistent with comparative figures presented earlier) came down, repeat down, from 14.2 percent to 3.7 percent. The same data set reveals that as at 4 October 2005 the price of Light Sweet Crude was USD 63.00 a barrel; an increase of 62 percent since April 2004. But during this period inflation has gone back up not by an amount that can be justified, but by huge three and a half fold; from 3.7 percent to 12.8 percent using the same measure. The fact of the matter is that oil prices have been going up rather severely during both the Ranil Wickremesinghe regime and the Rata Perata regime. But the irony is that while the rate of increase of cost of living came down during the former, it went up dramatically and unjustifiably during the latter.

Better to be realistic than live in a make believe world!
What is ironic is the fact that during the UNP regime pump prices of fuel was adjusted almost every month to reflect changing global prices. Technically, this pass through was the right thing to do as it kept the inflation impacts to a one-off event every time prices were increased. Why the then government removed other targeted subsidies while passing through the oil prices is a political issue that I am not qualified to discuss here. But as opposed to the Wickremesinghe government, the Rata Perata government kept subsidizing the fuel prices in an attempt to control inflation which caused the widening of the deficit which then resulted in printing money that fed into much greater inflationary impacts until it got out of control. Only then did the government adjust prices; by which time the vicious cycle of supply push-demand pull inflation feeding mechanism had already started.

Incompetence is not an excuse
In conclusion it is clear that it is possible not just in other countries, but in our own, to hold the soaring cost of living even under increasing world oil price regimes. Not that oil prices do not have an impact; it sure does, but not one that is justifiable in the face of soaring inflation we are currently experiencing. The Ranil Wickremesinghe government had shown how it could be done, and almost every country in the Developing Asia has also been successful in maintaining single digit inflation.

The bottom line is there is no validity in the Samaraweera argument that it is not possible to control cost of living increases when the oil prices are increasing. In fact inflation measured on a point-to-point basis came down over the last few months even though oil prices continued to increase. And that was thanks to the price revisions at the pump and the Central Bank raising interest rates to control demand pull inflationary pressure after heavy criticism from many quarters. This reminds me of some of the television talk shows in which the JVP freshmen appeared in 2004. I remember them asking why we needed a government if it could not hold rising consumer prices just because oil prices were going up. They were right. They should ask themselves or the remnants of their Rata Perata regime that question. I honestly hope that the people of this country will not be made to suffer due to incompetence of politicians; be it with the Rajapakse camp or the Wickremesinghe camp.

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