Rising inflation a matter of concern

Inflation as measured by the Colombo Consumer Price Index (CCPI) has been rising to dizzy heights causing anxiety and worry to monetary authorities as well as business community. According to the Central Bank inflation has been on the increase since April 2006 and reached 19.3 % in December 2006 and jumped to 20.5 % in January 2007. It is widely believed that inflation above 20% could cause many economic setbacks. This has prompted the authorities to increase the policy rates by 50 basis points. The policy rate increase will result in an increase in short term interest rates and the cost of credit and may also seen as inhibiting growth.

Understandably the Sri Lankan economy is engulfed by serious problems such as persistent current account deficits and ever widening budgetary deficits. Current account deficit has been mitigated by worker remittances a source that may not be sustainable. Inflationary trends have taken such dangerous trends prompting the President to express serious concern at the NEC (National Economic Council) and also instructing ministers to take prompt action to curtail this trend. However we feel that this problem has no simple short term solutions and serious commitment and long term planning by the government is the only option to at least save some hope for the future. Given the commitment to military expenditure in the war environment it’s a hard task for everybody. According to the latest government announcements tax revenue has recorded substantial gains and one hopes these trends will continue to add more strength to the economy.

Since the 1980’s inflation has been in the decline around the world with developed countries recording very low inflation figures. Not to be outdone developing countries like Sri Lanka too were able to record single digit inflation in the nineties. What’s even more striking has been the remarkable improvement in the Latin American countries that were able to reduce their three digit scores to single digit with the dawn of the 21st century.

Central banks the world over work towards price stability to achieve sustainable growth. Price stability does not indicate zero inflation but it’s a rate that’s considered sufficiently low so that planning and future developments are not impaired. Volatility in prices creates uncertainty in economic decision making, savings are adversely affected and speculative investments are encouraged. Increasing uncertainty may discourage saving and investment. It also argued that inflation destroys the poor and makes the rich richer, this is clearly seen in the Sri Lankan situation with land prices sky rocketing providing disproportionate returns to those who hold such assets while fixed income earners will be hard pressed to make the ends meet. Inflation also fuels trade union agitation for higher wages. Being a country heavily dependent on exports global price competitiveness too could be a casualty.

As a country, Sri Lanka is heavily dependent on imports with a growing export base that is subject to frequent swings in the exchange rates which affect the price stability. The other biggest issue is the shocks of ever increasing international oil price which has a tendency to escalate costs in every phase of economic activity. Poor planning and lack of foresight has brought the country to a virtual energy crisis with energy generation being heavily dependent on imported fuel. The immediate future too looks bleak and one could only expect cost increases. Even in this background all efforts to revitalize the electricity sector through much needed reforms seems to be stalled by the politicians. This is a matter the government must address seriously. Given the increasing demand for electricity each year power generation has to be given absolute priority irrespective of political winds.

While inflation is unavoidable during a period government is spending heavily on internal security and making investments in infrastructure certain measures could be planned to bring relief to poorer sections of the society who are struggling under rising prices. In this connection the government’s recent decision to exempt the electricity sector from VAT is laudable and a similar exemption in water too could cushion the household budgets.

We should follow the Indian example where basic needs such as clothing and food are available at reasonable prices within the reach of most people. In recent times successive paddy crops were able to deliver record quantities, but its difficult to see the desired effects of lower prices to consumers being achieved. Issues of storage and milling facilities have a clear impact on the prices. Then the transportation of vegetables from the farmgate to the wholesale market and ultimately to the consumer could be revamped to minimize losses in transit and also the middlemen margins.

The transport system and the traffic congestions too add to the delivery costs fuelling price hikes.