Sri Lanka has managed to bring inflation down tenfold. Why are we still struggling with ours?
It seems Sri Lanka may be well on its way to bouncing back from its financial crisis, which once seemed near impossible. As happy as we are to see Sri Lanka’s improvement though, our own inflation situation remains worrisome
Just a year ago, Sri Lanka was facing one of the worst financial turmoils since its independence, with record high inflation — a staggering 69.8% as of September last year — and foreign exchange reserves nearing depletion.
People suffered from regular power outages, increased energy costs and much more, leading to nationwide political unrest.
However, the country has recently managed to lower its consumer inflation rate to 6.3% in July from 12% in June of this year — a commendable achievement indeed. It seems Sri Lanka may very well be on its way to bouncing back from its financial crisis, which once seemed nearly impossible. And on 17 August, Sri Lanka repaid $50 million of the $200 million loan it took from Bangladesh in 2021.
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So how did Sri Lanka do it?
In a statement, the Central Bank of Sri Lanka (CBSL) mentioned that "this disinflation process is supported by the lagged impact of tight monetary and fiscal policies, improvements on the supply side, the softening of energy and food inflation, and the favourable base effect."
Moreover, the IMF bailout of nearly $3 billion in March 2023 (which bolstered forex reserves) along with lowered import restrictions and steps taken to improve power shortages helped in lowering the inflation by a great extent.
As happy as we are to see Sri Lanka's improvement, our own inflation situation remains worrisome. Rising food prices are especially concerning as we are struggling to buy something as trivial as an egg. According to Bangladesh Bureau of Statistics (BBS), the food inflation rate was 9.76% in July 2023 whereas it was 8.19% in July 2022.
The Business Standard reached out to experts to get an insight into why we are still struggling with reducing inflation when our crisis is not even as deep as Sri Lanka's.
Why Sri Lanka succeeded
Former lead economist at the World Bank's Dhaka office, Dr Zahid Hussain, said Sri Lanka increased its policy rate (short-term interest rate) significantly, which impacted their market. "They don't have interest rate controls like us. We have a cap on our lending rate, which is why increasing the interest rate or policy rate has no chance of creating an impact on the market."
He said among other conventional policy measures, Sri Lanka undertook fiscal austerity policies (reduce budget deficit by lowering government expenditure and/or increasing tax) to control inflation. Thus they may have increased tax or reduced expenditure or used a combination of both to reduce fiscal deficit.
Elaborating on Sri Lanka's financial crisis, Dr Zahid said, "Due to the Covid-19 pandemic, when tourism declined, Sri Lanka faced a tough blow and its foreign exchange rate reduced drastically. Since the country's dependency on tourism for foreign exchange earnings was very high, when tourism became zero, it was the final nail in the coffin in an already weak economy."
Increasing refinancing facilities during inflationary times means you are injecting more money into the economy. Perhaps it was done from an equity point of view, targeting small exporters etc, but that doesn't help inflation. [Dr Zahid Hussain, former lead economist at the World Bank's Dhaka office]
He added that Sri Lanka managed to negotiate with the IMF and address whatever concerns were raised by the IMF. "To get an IMF program, one has to do debt restructuring, meaning one has to sit with creditors and reschedule the credits and make a pledge for repayment. And we have seen its impact [$50 million repaid to Bangladesh]."
Dr Zahid further said that they may also have reached an agreement with the IMF on debt restructuring, which is why they got the nearly $3 billion bailout.
Executive Director of Policy Research Institute of Bangladesh, Ahsan H Mansur, opined that the crisis in Sri Lanka was different than ours and they had to make big adjustments as their exchange rate was sky-rocketing along with their inflation rate.
"In that situation, in that crisis mode, they used their interest rate. It was increased to more than 10% within a very short notice. To reduce inflation, they reduced it by around 4% but they are still following a tight monetary policy," he said.
"We could have taken steps like Sri Lanka but we did not. We probably would not have needed such drastic steps because our economy is not in shambles. We still do not have a crisis where as theirs is a post-crisis situation, the two have different backgrounds."
Where are we lacking?
Ahsan Mansur believes we have not even started our fight against inflation, so how will it be reduced? He said an unorthodox approach has led us to this situation.
He said, "Our economic narrative was that whatever is happening is supply side driven, it happened because of the Russia-Ukraine War and it will go away once the supply side improves and there is nothing we can do to change it."
That narrative is not fully right. We should have taken into consideration our demand side.
"When imports increased as part of our huge post-pandemic recovery, we should have understood that domestic demand played a role in it and it was not a supply thing. We did not pay any attention to it then, although now we have cut demand, as in we have cut imports, but we have not cut domestic demand."
Our economic narrative was that whatever is happening is supply side driven, it happened because of the Russia-Ukraine War and it will go away once the supply side improves and there is nothing we can do to change it. That narrative is not fully right. [Ahsan H Mansur, Executive Director, PRI]
He mentioned that if, like last year, a huge sum of new money is printed and circulated in the economy, "the inflation will rise from here, we won't have to do much." When base money will increase, it will create a multiplier effect and significantly worsen the situation.
Dr Zahid said there is a very simple answer to why Bangladesh has not been able to reduce its inflation rate. "Bangladeshi policy makers have talked a lot about reducing inflation without doing anything."
He blamed the cap on lending rate, monetary financing of the government budget (which is equivalent to printing money) and increased refinancing facilities behind the current situation.
"Increasing refinancing facilities during inflationary times means you are injecting more money into the economy. Perhaps it was done from an equity point of view, targeting small exporters etc, but that doesn't help inflation," he said.
"Suppose we create a Tk25,000 crore refinancing scheme for SMEs, the money goes out but those who require the money do not receive it. In that case, we will not get the productivity effect but the money has already entered the economy and that has created a demand which turns into an inflationary stimulus," Dr Zahid explained.
Ahsan H Mansur said we have problems on our fiscal side as well as our financial side. Opening up new banks also adds to the problem because as it is, our central bank is struggling to supervise the existing ones.
"We could have improved our situation last year had we taken the right policy. Instead we dragged it here, there seems to be no end to it. The right policy may be difficult, it might lead to a bit of contraction in the economy and slow down the growth. But we still need it," he said.
Dr Zahid Hussain said that the steps taken for revenue mobilisation is also inflationary as indirect tax such as custom duty, VAT, supplementary duty on various commodities have been increased.
"An overwhelming number of items have been subject to indirect tax increases, which have directly increased the price. When VAT increases, the seller does not pay, they take it from the consumer," he said.
