Economy

Sri Lankans suffering due to wrong policy: legislator

Sri Lankans are suffering due to wrong economic policy actions especially those involving state interventions in markets that are backfiring, a legislator who has earlier raised red flags about the balance of payments has said.

Harsha de Silva, an economist who represents Sri Lanka's main opposition United National Party said interventions in forex and interest rates markets had ended with heavy burdens on the people.

Interventions

De Silva said he had warned that when the central bank tried to "dictate to markets with artificial interest rates and exchange rates that was going to end with nothing but a crash landing that would significantly increase the economic burdens on the people."

Sri Lanka is now suffering from a balance of payments crisis which often hit so-called soft pegged exchange rate regimes where a central bank tries and fails to control both exchange rates and interest rates through sterilized foreign exchange sales.

A typically balance of payments crisis involving contradictory monetary and exchange rate policy triggers foreign reserves losses, exchange rate depreciation, high inflation, and high interest rates.

Such incidents can also trigger rating downgrades and capital flight, which makes the problem worse and difficult to manage and can result in a very severe recession.

If contradictory policy is not quickly ended with a clean float of the currency, high interest rates will persist for months on end, causing bad loans in banks, an economic slowdown which may hurt government revenues which in turn can renew pressure on interest rates.

Countries that discourage imports during balance of payment trouble, will further stump economic activity and state revenues, which in turn can put pressure on domestic interest rates and further delay a recovery.

The Great Depression was also prolonged due to import restrictions.

Root Cause

Sri Lanka started to suffer into balance of payments crises and 'foreign exchange shortages' after then finance minister J R Jayewardene, of the United National Party built a soft-pegged central bank with US help to join the failed Bretton Woods system of unstable pegs.

Before that Sri Lanka had a hard peg or currency board. In a currency board, the exchange rate is targeted or fixed but the interest rate is floated, creating complementary exchange and interest rates.

In 1971-73 the Bretton Woods collapsed and countries with greater monetary knowledge floated their currencies while Sri Lanka completely closed its economy.

In a floating regime, exchange and monetary policies are also complementary. The exchange rate floats but the interest rates are targeted or controlled. Both currency boards and floating exchange rates comply with the laws of nature.

Since the creation of the Central Bank the rupee has fallen from about 4.7 to the US dollar to 131 now.

From 1995 however Sri Lanka's monetary policy improved with the underlying law of the Central Bank also being changed.

However deficit spending, state interventions in energy pricing as well as losses in state enterprises, fiscal dominance of monetary policy has since triggered several balance of payments incidents.

In a 1999 balance of payments crisis the big loss makers were energy utilities, a state trading firm and transport utilities. This time it is state energy utilities and airlines.

Recurring Problem

De Silva referred to a recent Central Bank statement said that several measures taken in February 2012 has begun to have an effect.

"What it ought to have said is that “having completely mismanaged the external sector” the policy measures “forced” on the Central Bankby prudent economists, both locally and internationally, have now begun to have an effect," he said.

De Silva in January criticized a monetary policy roadmap saying it did not address a looming balance of payments problem.

"We ended cynically that the three words ‘balance of payments’ which was absolutely the most important issue of the day was not even mentioned in the roadmap presentation and thus it was like staging Hamlet without the Prince of Denmark," de Silva said.

Some analysts have called for the Central Bank to be abolished to give people freedom from exchange rate depreciation, frequent balance of payments crises and high inflation.

Under a currency board economic downturns will be largely limited to crises in the anchor currency. Analysts say even that can be countered with a sovereign wealth fund that accumulates seniorage profits of the currency board.

"The UNP having introduced the market economy to Sri Lanka has continued to appeal for just and equitable economic policies that provide economic freedom to people to work hard and create wealth in an appropriately regulated market economy," de Silva said.

"We have always favoured and continue to push for policies that help markets develop instead of disrupting well-functioning markets."

Photo courtesy: Eisenhower Fellowships

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