Sri Lanka’s rising food prices belies deeper economic issues
Posted on October 22nd, 2021

Author: Dushni Weerakoon, Institute of Policy Studies of Sri Lanka Courtesy East Asia Forum

Sri Lanka recently passed emergency regulations to deal with food shortages and price increases. Such powers are typically invoked to address public security concerns. But in this instance, they are being used to give the government extra powers to seize stocks of essential food items hoarded by traders. This justification sidesteps a fundamental question about the economic policy choices that have created the need for such drastic measures. An artificially maintained ‘official’ exchange rate in an economy hobbled by high debt levels has disincentivised food importers from releasing stocks at controlled domestic prices.

Woman buys essential food items at the supermarket after the Sri Lankan Government imposed a maximum price rate for key foods, Colombo, Sri Lanka, 3 September 2021 (PHOTO: Reuters/Akila Jayawardana/NurPhoto)

At the outset of the COVID-19 pandemic, the economic odds were heavily stacked against Sri Lanka. It entered 2020 with a government determined to cast off the shackles of an IMF austerity program, over the course of which GDP growth plummeted to an 18 year low. To revive economic activity, generous tax cuts were announced, which trimmed nearly 25 per cent off government revenues. These, together with the pandemic related economic crunch, saw 72 per cent of government revenue in 2020 swallowed by interest payments on debt, leaving little money left over for other critical spending.

As the fiscal floodgates opened, sovereign downgrades and widening spreads on its international bonds meant that crucial access to capital inflows got cut off. Sri Lanka’s central bank stepped in to help the Treasury, raising direct financing and placing caps on interest rates to keep borrowing costs down. As a net food and fuel importing economy, money creation on a large scale typically spills over into consumption spending and associated pressure on the currency, which adds to the domestic value of outstanding debt. Import restrictions, including on consumer food imports, are being used to tackle foreign exchange pressures.

Whatever foreign exchange is being saved is insufficient to ward off currency pressures. An uncomfortably high debt load — at a hefty 101 per cent of GDP against an emerging market economy average of 65 per cent of GDP — involves a sizeable foreign debt repayment. With 40 per cent of Sri Lanka’s debt denominated in foreign currency, the annual foreign debt settlement will average US$4–5 billion in the coming years. But foreign currency reserves had dwindled to US$3.5 billion as of August 2021. Predictably, efforts by the central bank to impose a cap on the exchange rate amid dollar shortages have led to significant foreign exchange market turmoil.

Import curbs, currency depreciation and dollar shortages are driving prices up. Hoarding is adding to the supply problem, with administered prices on key essentials such as milk powder and sugar not allowed to be adjusted. Notwithstanding price controls, food price inflation reached 11 per cent in August 2021, well above the general price inflation of 6.7 per cent. While supply disruptions owing to movement restrictions are partly to blame for rising prices, much of it is being driven by a combination of macroeconomic policy choices. Sri Lanka’s import restrictions also aim to align policy more broadly in support of domestic food production and import substitution efforts. Such policy shifts can lead to shortages as producers, traders and markets adjust.

With curbs and controls generating their own perverse incentives, the emergency regulations are in a sense the last option to make traders comply with orders to release stocks of certain essential food products to the market. Efforts to enforce the release of stocks to stabilise prices have been a long-standing problem in the case of Sri Lanka’s staple food, rice. Here, an oligopoly of private rice millers is often accused of hoarding to jack up prices. More generally though, shortages of other essential food items in the market today are more a fallout of economic policy actions in practice. In these circumstances, powers to raid warehouses are not addressing the root causes of prices increasing.

Instead, more crucially, attention should centre on tackling Sri Lanka’s financial crunch. Few would argue that the policy responses were misplaced given they constituted emergency actions to deal with COVID-19 related fallout. The problem is when temporary measures seem to become a more permanent mode of policy action. Indeed, the mainstay of debt monetisation programs is policy credibility — that is, an assurance that central banks will not fund fiscal spending indefinitely.

Sri Lanka needs to start by anchoring its fiscal plans to some notion of sustainability. This will give it more space to defend its sovereign rating and prepare to re-enter international capital markets. It has successfully met all its debt payments despite disquiet among investors, reflected in sovereign yield spreads, and has vowed to honour all future debt settlements. Instilling and maintaining a credible economic adjustment path that begins on the fiscal front is surely the means to anchor expectations and alter perceptions about Sri Lanka’s post-pandemic economic future.

Dushni Weerakoon is the Executive Director and Head of Macroeconomic Policy Research at the Institute of Policy Studies of Sri Lanka.

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