Navigating salary hikes amid the storm of inflation

By Dhananath Fernando

Originally appeared on the Morning

Sri Lanka is currently going through a difficult period and this extends to Government sector employees as well. In light of these difficulties, there have been recent discussions centred around the possibility of a salary hike of Rs. 20,000 for Government sector employees in the upcoming Budget. While a salary increment is desirable, a more effective policy-level alternative could be maintaining a low inflation rate, which is more than equivalent to a salary increment across the board. 

The call for salary increments in the Government sector intensified following last year’s inflation, which exceeded 70%. Private sector salaries are just now adjusting to the new economic landscape. Inflation is a significantly more severe and burdensome tax on people, and unfortunately, we have been experiencing its effects over the last year or so.

Government employees are undeniably facing a challenging period, but it’s crucial not to overlook the fundamental cause of the high cost of living. The current cost of living crisis is the direct result of carrying out excessive money printing, as endorsed by the Modern Monetary Theory (MMT).

If the salaries of Government sector workers are increased by Rs. 20,000, a simple back-of-the-envelope calculation suggests that it will cost the Government an additional Rs. 360 billion (1.5 million Government employees x Rs. 20,0000 (increment) x 12 (months) = Rs. 360 billion). 

For the year 2023, the expected Government revenue from PAYE Tax is approximately Rs. 100 billion following the tax revision. Notably, the salary increment alone requires more than three times the amount of tax collected through PAYE Tax.

In 2022, the collection of VAT amounted to Rs. 464 billion. This proposed Government sector pay increase would equal more than 75% of the total VAT collection. Even with a more modest increment of Rs. 10,000, it would still be 1.5 times the PAYE Tax collection and one-third of VAT collection. 

An alternative approach to financing this salary increase is to borrow from the Central Bank. Since the new Central Bank Act imposes significant restrictions on borrowing, it is not entirely impossible, especially during the transition period. 

If the Government opts to borrow from the Central Bank to cover additional expenditure while artificially keeping interest rates low, a second round of high inflation becomes almost inevitable. On the other hand, if the Government borrows at market rates, it would result in an increase in interest rates, potentially slowing down economic growth and creating challenges for businesses. 

If the Government intends to pursue this path, it is advisable to let interest rates fluctuate rather than resorting to money printing and keeping interest rates artificially low. This is because, in the aftermath of a high inflation cycle, there was an inevitable need to raise interest rates to curb inflation. 

On the other hand, we need to keep in mind that the last inflation cycle pushed four million Sri Lankans below the poverty line, bringing the total number of people in poverty to seven million. This has forced many to reduce the number of meals or the size of their meals. The latest reports indicate a rise in malnutrition levels, particularly among infants. 

Given the limited resources, the Government should prioritise assistance for the truly vulnerable and allocate the limited resources to social safety nets. For the last two months, the new Aswesuma programme has faced delays in cash distribution due to various political and logistical challenges. By continuing to not prioritise social safety nets, the Government is inviting instability at the grassroots level. 

International partners and donor agencies have generously supported the establishment of these social safety nets by providing foreign exchange. Delaying and complicating the process may result in the perception that addressing the issue is of lower priority, potentially reducing the willingness of stakeholders to contribute further.

According to the Appropriation Bill tabled in Parliament, total Government expenditure is expected to exceed Rs. 6 trillion for the first time in history. A substantial portion, over Rs. 2.5 trillion, accounts for interest expense on loans. There is limited room for new expenditure items as we are already on an IMF programme and any deviations could have a direct impact on debt restructuring. 

High inflation, though currently low, has lasting negative effects from the previous year. This cost of living crisis, affecting all citizens, particularly hits those below the poverty line. Some of the potential solutions may be challenging and carry potential risks, so the Government must exercise caution in implementation to avoid exacerbating problems.