Points of view):
Just a few days ago, Ruwan sent his client his quote for a “paint job” he got from a company. When he went there at night, the listing had been approved. He was happy to receive the approved quote to paint a company building.
Ruwan is a self-employed “service provider” in many technical fields, such as painting, renovation, tiling, carpentry, and even appliance repair. His income was irregular, but so far he had no problem with that because his average income was better than any regular job.
However, as the economic crisis deepens in the country, it is now a completely different story; It is not easy to find work in Colombo, so their average income has dropped significantly. Along with the lack of work and income, the scarcity of basic necessities and services has disrupted the family life of the average urban population much more than that of those living in rural areas.
It was in this context that Ruwan got this paint job for at least a couple of weeks. Since she decided to start work without delay, the next morning he went to buy paints. Unfortunately, she was surprised to learn that the price of a four liter can of paint had risen by Rs. 1,500 overnight.
Angry, he asked, “What? It was only yesterday that I got the prices from you and sent the quote to the company. How is it possible that this morning the prices of paint have gone up like this?” The trader responded with a short answer: “Yes, but the government raised the prices last night.”
Ruwan couldn’t resist his angry reaction, “So you got this stock of paints last night after that!” He did not receive an answer to that, perhaps because it may be a question to avoid.
In an economic crisis like this, market uncertainties fueled by ad hoc economic policy choices open up opportunities to make a quick buck. In addition to the currency crisis and debt crisis, Sri Lanka is facing inflation; in fact, to be precise, stagflation!
The term “stagflation” is a combination of two words stagnation and inflation. The first term, stagnation, describes that the economy is in a steady state with no progress. In such a situation, economic activities subside and people lose jobs and income. It is a situation that many people like Ruwan face. At a broader level of analysis, we would see a slowdown in economic growth and an increase in unemployment and poverty.
The second term is inflation: continuous increase in average prices. Since October 2021, the average inflation rate in Sri Lanka has increased beyond the upper margin of the Central Bank’s inflation target zone, which is 6 percent. It increased to 7.6 percent in October, 9.9 percent in November, 12.1 percent in December, 14.2 percent in January 2022, and 15.1 percent in February. Price increases in the food category have been much higher; the food inflation rate reached a double-digit level in mid-2021, exceeding 20% in December and 25% in February.
Thus, stagflation is a double whammy on the average people’s standard of living. They lose income and jobs on the one hand due to “stagnation” and face price increases on the other hand due to “inflation”. Why did the Sri Lankan economy get into this “stagflation” problem today? By carefully reviewing the underlying factors, it becomes clear that our own domestic problems combined with global developments have at the same time been at the core of the stagflation problem.
Among the internal problems, the number one that had multiple repercussions on the economy was the massive issuance of money. It was meant to meet the spending requirements of the government that faced the economic fallout from the COVID-19 pandemic in 2020 and its own political decision to cut taxes in 2019.
It is well known in the economic phenomenon that “prices start to respond after a lapse of time” to policies such as money printing, which we experienced from the second half of 2021. In addition, money printing also put pressure on the rate exchange. depreciation, due to the link between money and the external financial position. This forced the adoption of increasingly stringent import controls and foreign exchange restrictions, which also had multiple repercussions on economic affairs.
Import controls and exchange restrictions caused supply shortages in the local market that affected both consumption and production. As both exports and domestic production felt input shortages, local production and transportation were affected not only by the pandemic, but also by input shortages.
On the production side, another blow was the problem of the fertilizer policy that reduced the production and productivity of domestic agriculture and plantations. It has contributed to both the decline in export earnings and the domestic food supply. After all, the exchange rate depreciation that did not slow down added another dimension to the rise in domestic import prices.
As the global economic recovery progressed, global inflation was also on the rise. Every major economy in the world, including the US, the EU, the UK, and even Japan, is starting to see rising prices. In February 2022, in 12 months, the inflation rate increased to unprecedented levels from 2.6% to 7.9% in the US and from 1.3% to 5.9% in the euro area.
In particular, oil prices, food prices, and industrial commodity prices posted rapid upward trends that affected consumption, production, and distribution in both advanced and developing countries. Despite import controls and foreign exchange restrictions, Sri Lanka was largely unable to reduce its import spending, so the heat of global inflation was also felt in the domestic economy.
The problem has now been exacerbated by the conflict between Russia and Ukraine, which has far-reaching consequences on both global output and global inflation. The global economic recovery that began in mid-2021 has now apparently been significantly constrained by disruptions to production, trade, distribution, and financial flows, as well as economic sanctions imposed by Western countries.
Russia and Ukraine are major suppliers of oil, gas, coal, wheat and other grains to the world market. As a result of the war, energy prices are rising, affecting manufacturing production and transportation. Food prices are rising, not only due to war-related disruptions, but also due to rising energy prices.
In fact, Sri Lanka’s current inflation rate is the highest in Asia. It reveals that the domestic factors underlying your current inflation are much more significant than the global factors. Having faced multiple economic problems, the country’s vulnerability to inflationary trends appears to be greater than ever.
The main issue at hand is getting out not only from the clutches of severe inflation trends, but also from economic stagnation, supply shortages, debt crisis and currency crisis. The most important question is what were the specific political measures that Sri Lanka implemented in the last two years?
As we continue to delay responding to emerging crises, the country is now approaching a time when the “exit” requires severe austerity measures: tough policy measures to cut government spending, raise taxes, and restrict growth in the money. Austerity policy measures could be economically painful and even more costly politically.
(The writer is a professor of economics at the University of Colombo and can be reached at firstname.lastname@example.org and followed on Twitter @SirimalAshoka.)
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