Any government’s biggest enemy is INFLATION

Originally appeared on The Morning.

By Dhananath Fernando

Friedrich Hayek famously said, “I do not think it is an exaggeration to say history is largely a history of inflation, usually inflation is engineered by governments for the gain of governments.” While there are many reasons for the ‘Aragalaya’ to advance and develop as a movement, the economic context for movements such as the ‘Aragalaya’ taking off should not be underestimated. 

Those who remember our recent history will recall a similar ‘Aragalaya’ in 2001-2002 called ‘#JanabalaAragalaya’. During that time as well, Sri Lanka’s currency depreciated significantly and cost of living was on the rise. In fact, every time Sri Lanka’s currency depreciated and inflation started soaring, we would see similar kinds of people’s protests rising to prominence. 

Inflation leads to crisis

Today we are going through one of the largest crises in our history and the people’s resistance has been reflective of what we are going through. That is why it is said that the biggest enemy of any government is not the opposition, but inflation. 

Unfortunately, many governments and central banks around the world have not realised this truth and have created inflation by lending their respective governments money without any control; they followed reckless monetary policies without understanding the gravity of their actions.

Another currency crisis hit in 2011-2012, which led to the build-up of pressure on then President Mahinda Rajapaksa. Later, in 2016-2017, yet another currency crisis took place, with pressure mounting against the Yahapalana Government in connection with the Bond scam. Since 2019, Modern Monetary Theory (MMT)-led money printing has undoubtedly been one of the main reasons for the crisis we are experiencing today. 

When countries that do not possess a global reserve currency as the national currency add money to their economy, that money will generally chase behind imports, which require foreign exchange. If the country allows the currency to fluctuate automatically, the prices of imports will increase and demand will drop without any forex shortages. But if a country is trying to control the exchange rate using its reserves, unless it has a mechanism to continuously build reserves, at some point it will encounter forex shortages followed by steep currency depreciation. 

Perfect storm 

Sri Lanka has often faced this same problem, which is also the reason we always face currency crises. The present crisis is of historic proportions, as it is accompanied by a perfect storm of so many other policy errors, along with deteriorating global conditions. 

Since 2008, we have had the option of borrowing from markets. We complicated our problem by borrowing money at high interest rates to build our reserves as well as to keep the exchange rate controlled and artificially high. 

Ultimately, we have lost control of everything, and now we have a USD shortage which has led to many shortages of essentials. Since we have borrowed money from international markets, we are now experiencing a debt crisis. Further, due to our own banks investing in sovereign bonds, the stability of our financial system is in question. 

The graph shows the currency depreciation since 1970. We can observe what has happened in recent years to understand and validate Freidrich Hayek’s statement that history is a history of inflation. 

Solutions 

The first part of the solution is for all future and potential leaders and governments to understand that one of the main potential enemies of the country is the inflation they themselves have the power to create. On the other hand, central banks should understand that their excessive lending to governments can lead the country to absolute chaos and instability.

Therefore, regulation has to come forward for inflation targeting and to have a limitation on lending capacity of central banks to governments to ensure stability in our financial system. 

The already-drafted Monetary Law Act is a good starting point for the new government and finance minister and getting it approved with necessary amendments and inflation targeting is an easy win that will establish and indicate the direction of monetary stability. When inflation starts moving upwards, bringing it down is not an easy task, so we should make sure to keep it in check before it takes control and sends every other aspect out of control. 

Sri Lanka is at a crossroads, where we undoubtedly need a sequence of reforms. If we implement the reforms that are required, we have the potential to become a tiger economy, but if we continue to behave with old habits and allow inflation to take us over with our bad monetary policy, we will become a failed state. 

The opinions expressed are the author’s own views. They may not necessarily reflect the views of the Advocata Institute or anyone affiliated with the institute.

Economic ‘Aragalaya’ crucial for reform

Originally appeared on The Morning.

By Dhananath Fernando

SL economy has reached point of collapse; needs a total reset to recover

Every day on my way to work I walk past 5th Lane, the current Prime Minister’s residence. Last week, one of his security officers stopped me. He smiled and said, “Sir, we watch videos of Advocata Plus.” After a moment, he continued: “What is actually happening? How long will it take to recover?” I didn’t have a concrete answer. I couldn’t adequately answer him because our path to recovery depends on our course of action. 

The only certainty is the fact that it’s going to take time. Yet, to refrain from discouraging a hopeful individual, I smiled back, and said: “It’s a difficult time and recovery will be slow, but we will recover if people like the Prime Minister make the right decisions and policies.” His response was heavy with emotion, as his eyes brimmed with tears: “Our time is over. I thought we could make our children’s lives better, but now I can’t even provide my kids with what my parents provided me. It hurts, sir.”

The story of many Sri Lankans is no different. This is why we need a complete reset of our economy. The existing system, which we have inherited, cannot move forward any further – a point of collapse has been reached. The collapse has been painful and recovery takes time, but in order to ensure that we successfully overcome this collapsed system, an ‘Aragalaya’ for economic reform is absolutely crucial.

A question remains. What can we do to overcome and speed up our recovery? One common mistake many policymakers make is that they only see a fraction of the bigger picture. Reviving tourism, or getting remittances, or bridge financing is seen as a solution. However, these are just smaller concerns in a much larger problem. 

The core issue is that our economy is not competitive. Having existed as a closed economy for an extended period of time and losing our competitive edge has caused the Sri Lankan economy to lose its overall competitiveness. Many believe in the myth that our economy has been open since 1977, when in reality it has been closing down since the 1990s. One of the best indicators to measure this is through the comparison of our imports and exports to the size of our economy – both of which have been declining at a record pace since the 1990s. Exports are the indicator to measure our relevance in the global market and the declining trend in our exports means that we have become less relevant to global markets. 

Why is Sri Lanka losing competitive advantage? Firstly, the nation’s factor and product markets have not experienced any major reforms for decades – and in some cases for centuries. As Charles Darwin said in his Theory of Evolution, only those who adapt will remain. Sri Lanka did not adapt and thus became irrelevant. The country’s land market is virtually a closed market, with approximately 82% of the land owned by the Government, which causes one of the main factors of production to be hindered. 

Secondly, labour market reforms have not been implemented. Even in 1977 there were no labour market reforms. Hiring and firing employees is a very difficult process and stringent regulations on part-time work and flexible work hours are preventing Sri Lanka’s growth. On the supply side, productive labour remains glued to the Government sector, with very low salary scales despite having the potential of contributing to the economy in a far bigger capacity.  

Sri Lanka’s public sector employment, which was at 812,472 in 1994 (1), increased to 909,564 by 2002. By 2020, public sector employment was at 1,423,116 (2). The latest figures report 1.58 million public sector employees, making Sri Lanka home to one of the highest ratios of public sector employees in Asia (3).

The current economic crisis has brought the country’s public sector finances and savings to shame. With 54% inflation and more than 100% currency depreciation, EPF/ETF savings and the pensions of the public sector have been reduced to an amount that means little in comparison to skyrocketing living expenses. 

While the situation is unfortunate, it can be capitalised upon to enact public sector reforms. The first step would be to first freeze all recruitment and offer a retirement scheme to bring the employee numbers down. We can cut down the number of working days for public servants and consider different types of voluntary retirement schemes to hedge costs. There needs to be a prioritisation of public servants and the salaries of capable staff should be increased, with adequate training opportunities provided to enable further refinement of skills.

The current structure of public workers is not only negatively impacting their own lives, but also making the lives of the general public quite difficult. As a result, similar to the Prime Minister’s security personnel, most of us are unable to provide our children with what our parents provided for us. As such, public sector reforms have to occupy a core spot in the ‘Aragalaya’ to ensure economic reform. 

When suitable policies that can bring macroeconomic stability are implemented, the micro pieces will adjust accordingly. Thus far, the strategy has been micromanagement rather than macro stabilisation. However, when necessary Government policies attend to macromanagement, micromanagement will naturally be provided for by the private sector.

In the investment sector, labour and land have once again been key constraints, as the country lacks adequate land to provide investors. Zones managed by the Board of Investment (BOI) have run out of plots of land and getting new land for development has become a nightmare. Until the newly-appointed Minister of Investment Promotion offered a five-year visa for foreign investors, we did not even have a programme to attract talent and investment through our immigration system. 

If the macro policy is sound and a level playing field is created for all, then future generations will be better equipped to take care of themselves. One very important component of the ‘Aragalaya’ for economic reforms is our monetary policy, since without fixing our currency and the value of the notes we exchange, macro stabilisation will be a futile effort. 

References:

• Census of the Public and Semi-Government Sector Employment 1994, Department of Census and Statistics. http://www.statistics.gov.lk/PublicEmployment/StaticalInformation/census_reports/CensusOfPublicAndSemiGovernmentSectorEmployment-1994FinalReport

• Ministry of Finance Sri Lanka Annual Report 2020, treasury.gov.lk. https://www.treasury.gov.lk/api/file/0b7d1935-6235-4156-97b6-752d6a8039d0

• Employment in Public Sector and by Gender, OECD iLibrary. https://www.oecd-ilibrary.org/sites/2558c185-en/index.html?itemId=/content/component/2558c185-en

The opinions expressed are the author’s own views. They may not necessarily reflect the views of the Advocata Institute or anyone affiliated with the institute.