One of the popular topics of discussion in Sri Lanka and the main concerns for the public at large today, is the cost of living and its impact on the livelihoods of people over time. Cost of living is the average cost of the basic necessities of life, including food, shelter, and clothing. This is statistically represented through a wider measure known in economic terminology as ‘Inflation’.
Inflation measures the pace at which the general level of prices for goods and services is rising and, consequently, the purchasing power of the currency falling. Inflation as measured by the Colombo Consumers Price Index (CCPI) in Sri Lanka reflects the percentage change in the cost to the average consumer of acquiring a basket of goods and services compared to a specific time interval, usually a year. From an individual’s point of view, it is important to watch out for inflation since a persistent rise over shorter periods of time could have a drastic, adverse impact on the purchasing capacity, thus, reducing the ‘standard of living’.
The consequences of a sharp rise in inflation could be acute to the average person with a daily or monthly take-home pay, as income levels do not increase frequently, proportionate to changes in inflation.
Therefore, as inflation has vast economic and social repercussions on society at large, the authorities must implement appropriate policies to continuously monitor inflation so that it is kept in check at an acceptable level.
Role of the Central Bank
One of the two core objectives of the Central Bank of Sri Lanka (CBSL), as the country’s monetary authority, is the maintenance of price stability. Price stability safeguards the value of the currency in terms of what it will purchase at home and in terms of other currencies.
As the experience of many countries suggest, economists opine that stable prices, and not necessarily low inflation, promotes economic growth. It allows everyone to make better decisions regarding what to produce and how to produce, thus enabling more efficient allocation of resources.
Hence, the CBSL adopts an appropriate monetary policy to contain monetary expansion at an appropriate level and perseveres to maintain a moderate inflation rate in mid-single digits of around 4% to 6%.
Causes of inflation
In order to address inflation, it is vital to identify the sources of inflation.It is generally recognized, in the short term, mainly, supply side factors or structural issues cause inflation.
Therefore, analysts suggest that policy measures should focus on addressing such issues and expanding production.
According to statistics computed by the Department of Census and Statistics of the Central Bank of Sri Lanka, the island’s headline (overall) inflation in year 2017 grew sharply by 7.1% compared to 2016.
“This was entirely due to supply side disruptions, due to the weather,” Central Bank Governor Indrajit Coomaraswamy told a recent business forum organized by the Ceylon Chamber of Commerce.
According to the Governor, the Central Bank, through the implementation of its monetary policy is only capable of influencing coreinflation which reflects the underlying inflation in the economy.
The core inflation is measured by excluding items such as, fresh food, fuel, transport, rice and coconut.
“In 2017, food price inflation reached over 13 percent. It peaked about 3 months ago. Now, there is very little that monetary policy can do to address supply-disruption driven increases in inflation.
That the government has to address through increasing supplies,” the Governor told the forum.
However, in January 2018, inflation eased to 5.8% from a year earlier, recovering from a peak of 8.8% YoY witnessed in October 2017, amid a considerable slowdown in food inflation.
Tackling food inflation
Though Sri Lanka is not self-sufficient in food, and relies on imports of wheat, rice and maize to meet domestic demand, the agricultural sector is one of its critical sectors meeting a majority of annual domestic demand.
However, during the last few years, Sri Lanka has been wreaked by a series of natural disasters like floods, drought and even landslides, ultimately affecting food supplies and triggering a rise in domestic prices.
“Sri Lanka has been very sensitive to weather-related disruptions. As disasters in the recent past have been more extreme and also more frequent, Sri Lanka has to improve resilience without relying on stop-gap measures,” Chief Economist of the Ceylon Chamber of Commerce, Shiran Fernando said.
Pointing out that the country needs to implement policies by looking at it from a long term perspective, he highlighted that the current method of reliance on imports, as a stop-gap measure to fulfil supply-chain disruptions is unsustainable.
“We need to also look at how we can make agriculture more productive,” Fernando added.
Climate resilience measures
Meanwhile, Research Economist at the Institute of Policy Studies in Sri Lanka (IPS), Kanchana Wickramasinghe says, climate resilient agriculture definitely leads to reduce supply side shocks due to climate induced events. As a result, this can also have an impact on inflation.
According to research conducted by the IPS, farmers in the Anuradhapura district ranked top in climate induced disasters with the risks and uncertainties faced by them. Over three-fourths of the farmers have been affected by at least one disaster event during the last five years.
“While the economic costs of disasters are on a rising trend, there is a growing interest among the international community to improve the resilience of vulnerable communities under two major disciplines, namely, disaster risk reduction (DRR) and climate adaptation.
“It is essential that climate adaptation policies and measures are built on the existing DRR frameworks in order to be efficient and effective,” the policy think tank advocated in its flagship publication ‘Sri Lanka: State of the Economy 2017 Report’.
According to Wickramasinghe, although international initiatives and mechanisms and Sri Lanka’s commitments to them have shaped the disaster management framework to a considerable level, significant gaps remain in relation to coordination and integration.
“As disaster management is a cross-cutting issue, it is essential to mainstream and integrate disaster management aspects in development policies and planning. This is a highly considered area in Sri Lanka’s policy making, and certain steps have been taken to integrate disaster management in development activities. However, it needs further improvement. If not, the absence of a common and shared framework constraints donor investments in DRR,” she points out.
Protectionism-induced inflation
On the other hand, economists opine that in the case of food products, it will be much cheaper if the current heavy protectionism is reduced. Currently, the government while supporting the farmers by providing them with subsidies for cultivation to keep production costs low also imposes various tariffs on imported food products, artificially rising prices of imported products.
The rationale behind the move is to make domestically produced food attractive for local consumers, as approximately, 30% of the total population is dependent on the sector for survival.
“One way the government could reduce inflation is by reconsidering its policy of prioritizing producers (farmers) over consumers by restricting imports, by imposing Special Commodity Levy, etc. on imported basic food items,” opines an economist attached to the public sector.
The official says, in the interest of protecting farmers who grow them, what actually happens is that a vast majority of consumers are suffering with high prices, as against a small number of producer farmers who gain from preventing imports. According to him, this has proved to be a complete folly and the government has to reconsider the balance between the consumer interest and the farmer producer interest.
“It was the same issue with potatoes where a small group of producers of potatoes in Sri Lanka, lobbying for protection against imported potatoes, when there are millions of consumers of potatoes.
“I think, it is this flawed policy of protectionism that has contributed to rising food prices, and as a result the cost of living,” the economist who did not wish to be identified, pointed out.
Way forward
The Minister of National Policies and Economic Affairs recently established a Family Economic Unit to monitor and obtain information regarding a household economy. The new unit was established following a directive issued by Prime Minister Ranil Wickremesinghe.
“At present, we have data on the country’s economy but have no mechanism to collect data regarding household economies.
If the cost of living is high, then we should pay attention to factors such as, the price of food items. This data will help us support and serve households and families better,” Wickremesinghe said.
“Food cost isn’t the only expense for a household. Transport, clothing, tuition fees, telephone and mobile charges, rent and preschool fees are among the other expenses of a family. Some households spend more on these expenses than they do on food. So then, what is the total expense of a household? What is their income? How does it affect the economy? And how does the economy affect a household? Questions such as these and many more can be answered through this Family Economy Unit,” the Premier explained.
On the other hand, the Central Bank of Sri Lanka has announced that it will move to a Flexible Inflation Targeting Framework from 2020, gradually replacing the monetary targeting framework being followed at present. Under this initiative, it has been planned to stabilize inflation in mid single digits over the medium term while supporting economic growth objectives and flexibility in exchange rate management.
Accordingly, the Central Bank is planning to amend the Monetary Act to make arrangements to ensure that the Bank is accountable for meeting the target.
“These amendments would broadly include strengthening the mandate of price stability, separating the monetary and fiscal functions, strengthening the Central Bank’s autonomy, and introducing institutional arrangements for setting inflation targets and maintaining accountability,” Central Bank Governor Indrajit Coomaraswamy said, presenting a road map for Monetary Policy in 2018.
Coomaraswamy has said, Sri Lanka will also target an inflation adjusted exchange rate relative to its competitors and gradually move the real effective exchange rate to 100.
Hence, one hopes that going forward, the implementation of appropriate strategies will keep Sri Lanka under a desired and predictable inflationary environment.