SHOULD WE CURTAIL THE COST OF PRODUCTION OR INFLATION?
Posted on November 28th, 2022

By Shivanthi ranasinghe Courtesy Ceylon Today

Last Friday (25 November 2022) at the event, Driving Towards a Resurgent Economy, organised by the Business Economics Studies Association of the University of Colombo, delivering a keynote speech Central Bank Governor, Dr. Nandalal Weerasinghe defended the high interest rates. 

Currently, inflation is on the wrong side of two-digit numbers. Thus certain sectors, acknowledged Dr. Weerasinghe, as construction are hit hard by the ongoing economic crisis.

Inflation is only 70 per cent, but the prices of cement and other raw materials have gone up by 300 per cent,” pointed out Dr. Weerasinghe. 

He, thus, asserted that businesses must first survive before they can grow. Therefore, instead of focusing on interest rates, the first step would be to curtail the prevailing inflation, he said. This was a must, he emphasised, if we are to avoid a Zimbabwe kind of experience. 

Except for that in the financial sector, he observed, If we take cost of production of any business as 100, the cost of finance or interest accounts for less than 10 per cent as per empirical data. The remaining costs are related to raw materials, imported goods, transport and so on.”

Therefore, he noted, When inflation goes up by 100 per cent, 90 per cent of the production costs rise by 100 per cent. If we let businesses borrow at five per cent while 90 per cent of that cost structure is rising by 100 per cent, can they survive? So, what’s more important? Should we curtail the cost of production or inflation?”

Businesses recover their costs by increasing the price of the output, he explained further. 

If inflation is allowed to spiral out like in Zimbabwe, which is at 400 per cent, there won’t be any businesses,” he stated. 

What happened to Sri Lankan economy?

Many of those who venture to speak on the difficult subject of the prevailing economic crisis use Zimbabwe’s economic crash as the benchmark to avoid. However, whether Zimbabwe’s experience is the most relevant case study before us is questionable. 

To compare and contrast Zimbabwe’s experience, we must first understand Sri Lanka’s situation. Sri Lanka’s wobbling economy stems due to the combined chain reaction from five main causes. 

1. Lack of entrepreneurship 

2. Deliberate and consequential economic sabotage 

3. Excessive borrowing and overconsumption

4. The globally-affected Covid-19 pandemic 

5. Anti-government protests

Lack of entrepreneurship 

One of the devastating effects of the 1971 JVP insurrection was the loss of proprietors, who sold their assets and migrated. This was further exacerbated by the socialist reforms enacted by the 1970-77 Government of Sirimavo Bandaranaike. Though her administration is credited with initiating a number of local industries, the then socialist mindset disdained entrepreneurs. This was thus the decade that actively nurtured a hatred towards capitalists. To this day, many equate entrepreneurs to scoundrels who would do anything for profit. 

Though the J.R. Jayewardene Government opened the economy, reviving it from stagnation, the situation did not improve. While the open economy created a robust private sector, it was one that focused primarily on trading than manufacturing. 

The main reason for the manufacturing sector to languish was its inability to compete effectively against the imports. Hence, the open economy policy is being blamed for our lack of production. However, it is noteworthy that the economy was opened 45 years ago. Yet, we have failed to redress this issue for nearly half a century. 

We must then study what has prevented successive governments from taking the needful steps to rectify this situation and encourage new start-up businesses. Among the causes are:

1. Our education is geared to produce employees and not entrepreneurs. Governments like employees because they can be taxed. Conversely, governments may have to give tax breaks for entrepreneurs to encourage them to,

Keep robust supplies and manage costs, thereby control inflation;

Create jobs and thereby reduce unemployment;

Engage in projects that benefits the community as property development. 

2. Public perception favours imports over local produce. This is an unfortunate carryon from the days of European Forced Occupation. Though three quarters of a century has passed since regaining independence, we have not countered the occupier’s demoralising projects. This is costing us in more ways than one. 

3. Blundering policies that attempt to resolve the immediate issue without taking the overall picture into consideration. Most of our politicians have little or zero experience in the business field. Therefore, they do not understand the challenges faced by the business community. Elected for short periods, most politicians focus on staying elected by attempting to brown-nose voters than introducing much needed reforms. 

Deliberate and consequential economic sabotage

Since 1971 until 2009, the dominating news emerging from Sri Lanka was the acts of terrorism and unrest. Some of these acts deliberately targeted and destroyed strategic economic assets. Even the acts that did not directly target the economy created an atmosphere of uncertainty. This discouraged investors. 

While the country’s income and development thus suffered, expenses soared for defence and offense operations, to intensify security and look after the victims. Repairing, reinstalling, or replacing damaged assets too fell on the Government’s account. 

Excessive borrowing and overconsumption

Though the country’s finances were thus challenged, imports continued to flood the markets. Successive governments took the easy option to borrow to pay for imports than replace with local products or increase our exports. 

Cost of living has always been a contentious point, irrespective of which government presided. Yet, this has not affected consumption. One of the primary causes for our overconsumption is the subsidies and free handouts provided by the Government. 

For instance, during the Mahinda Rajapaksa Administration, infrastructure for power was expanded giving electricity to 99 per cent of the population. To help the economically challenged afford electricity, this was heavily subsidised. Since then, there has been no effort to analyse and understand if these subsidies have created better incomes and the possibility of adjusting the subsidies accordingly. 

Consequently, the Ceylon Electricity Board is in a financial mess. The Government is thus unable to help out crucial institutions as hospitals as they fall behind on their bills. 

The globally-affected Covid-19 pandemic

On the face of it, the Covid-19 pandemic was a double whammy for Sri Lanka. The island nation was just recovering from the heinous Easter Attack. With that, the country’s USD 4 billion per annum industry kneeled. Just as it was recovering, the global pandemic shut down the industry for the next two years. Overall, this cost the country a whopping USD 12 billion. 

There was also another challenge waiting for the country as the pandemic prolonged for over two years. The due dates to service debt came in close succession. At a time when all revenue avenues had shut down and the economies of all countries were suffering, negotiating and repaying these commitments became increasingly difficult. 

While the former Central Bank Governor Ajith Cabraal insists that we had USD 10.7 billion in the pipeline as credit, Dr. Weerasinghe as the incumbent disagrees. He claims that there was only USD 20 million while two loans worth USD 220 million had matured. Therefore, bankruptcy was declared to avoid a hard default. 

At the time, it was hoped that before the year ends we will be able to obtain a bailout package from the IMF. However, the Government has still not been able to negotiate a debt restructuring programme with the debtors – an IMF prerequisite. 

This has pushed the estimated expected timeline of the IMF bailout to materialise to mid-March 2023. Dr. Weerasinghe is confident that Sri Lanka will be ready to take its request to the IMF Board by January 2023.

In the meantime, we have lost creditworthiness. This has put the entire banking sector in jeopardy. Earlier, the banking sector was an assured stock to invest in regardless of the overall economic performance. Currently, people worry even to invest in a treasury bond despite the high interest rates offered. Other functions of banking as opening Letters of Credit too have been adversely affected. 

Anti-government protests

The anti-government protests that culminated to anarchy did not begin with the shortages of essentials and imports. Almost from the first day, President Gotabaya Rajapaksa took office there were daily protests. These were handled most diplomatically, without the usual Riot Police, batons, barricades or teargas. A separate ground just outside the President’s Office was created for protestors to protest peacefully. 

Yet, when protestors violated this privilege and protested in places as outside the US Embassy, forcing the Police to take decisive action, this was reported as ‘unprecedented’ or ‘excessive’ Police force. 

It is unfortunate that the Government failed to read the signs and bring forth laws to protect front line law enforcers. Consequently, the SSP of the Rambukkana Police was remanded for shooting a rioter, without taking into account the disaster he averted. This discouraged the security establishment to intervene and stop the mayhem on 9 and 10 May 2022 or stop rioters storming into the President’s House or Presidential Secretariat. 

As President Gotabaya tried to portray himself as an advocate of democracy, anti-government and anti-national forces took advantage and staged protests with the specific goal to sabotage the economy. This was highlighted with the trade union action of teachers and principals over an issue that had been simmering for quarter of a century. 

By doing so, the lockdowns prolonged as Covid-19 cases rose and delayed the economic recovery. The tourist arrivals coincided with the breakdown of essentials supplies. Utilising this deteriorating situation, the middle class sector was also encouraged to join the protests. This directly impacted tourism as it was making tentative progress. In April alone, due to these protests, tourist arrivals fell by 43.3 per cent. 

Naturally, this denied the country the much-needed forex. Needless to say, the economic crisis worsened. However, President Ranil Wickremesinghe is not as fussed to be seen as politically correct. Himself a victim of the anarchists, he has taken tough measures to bring normalcy to the country and has vowed action against any who tries to create unrest in the country. Currently, this is the junction we are at as a country. 

Therefore, it is from this point we must evaluate if we are indeed in danger of a Zimbabwe-like scenario as Dr. Weerasinghe warned if we fail to curtail inflation. Simultaneously, we must also understand if we ought to save or invest, boldly expand the economy or cautiously contract it. These will be the issues this column will discuss in the coming weeks. 

ranasingheshivanthi@gmail.com

(The views and opinions expressed in this column are writer’s own and do not necessarily reflect the official policy or position of Ceylon Today)

By Shivanthi Ranasinghe

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