Inflation is universal but factors leading to inflation aren’t

23 Jan 2022

Inflation is universal but factors leading to inflation aren’t

23 Jan 2022

By Madhusha Thavapalakumar According to Trading Economics, the monthly inflation rate of Sri Lanka hit 12.1% in December 2021 – from 9.9% the month before – the highest rate in the 13 years since December 2008. There is a shortage of several products in the market and consumers have to stand in queues for hours to purchase certain items. Soaring inflation is a struggle not only for Sri Lanka but for many other countries as well, some of which have developed more than us, but are the factors that led to inflation in these respective countries the same as ours? That is what the Market Mine of The Sunday Morning Business is looking at this week. Sri Lanka’s growth from single digit to double digit inflation The Central Bank of Sri Lanka before the pandemic, during the tenure of Governor Dr. Indrajith Coomaraswamy, had curbed demand pressures in the economy and maintained inflation at a low level. In fact, in 2016, the Central Bank officially announced that it would be gradually moving towards a flexible inflation targeting framework, thereby replacing the monetary targeting framework that existed at the time. Under this enhanced framework, the Central Bank focused on stabilising inflation at mid-single digits over the medium term while supporting growth objectives and flexibility in exchange rate management. Generally, an inflation targeting framework is characterised by an announced numerical inflation target or medium-term inflation forecast, which facilitates forward looking monetary policy decision making and a higher degree of transparency and accountability. In September 2019, Coomaraswamy announced that the Central Bank had pretty much completed the transition towards a flexible inflation targeting regime from the monetary targeting framework. As a result, according to the Central Bank’s Annual Report for the year 2019, despite transient supply side disturbances, both headline and core inflation moved broadly in the desired range of 4-6% during 2019, mainly as a result of subdued demand conditions and well anchored inflation expectations. “With survey-based upward adjustments to house rentals and education fees, headline inflation, as measured by the movements in the Colombo Consumer Price Index (CCPI) accelerated at the beginning of 2019. Contributed to by the revisions of administratively determined prices and taxes on certain food and non food items as well, CCPI-based year-on-year headline inflation accelerated from 3.7% in January 2019 to 5.0% in May 2019, before easing during the ensuing three months to record 3.4% in August 2019,” the report highlighted. According to the Central Bank, generally, unsustainable budget deficits boosted excess and untenable demand in the economy. When there is excess demand, it leads to inflationary pressures and higher nominal interest rates in the economy, and there is also a higher propensity to import, given the limitations in domestic supply. That in turn exerts pressure on the balance of payments and the exchange rate. This has been the Sri Lankan experience over several decades, which stands in marked contrast to the policies of the successful East and Southeast Asian countries. Those countries have robust fiscal outcomes, low inflation, low interest rates, and competitive exchange rates. Once, Coomaraswamy stated that Sri Lanka cannot continue with repeating stopgo cycles, with each successive trough becoming more dangerous and we have to change with vigour in order to achieve our objectives. However, in 2020, despite the pandemic, headline inflation remained broadly within the desired range of 4-6 %, while core inflation remained low throughout the year, according to Central Bank data. According to the Central Bank Annual Report for the year 2020, headline inflation, as measured by the CCPI, hovered around the upper bound of the desired range during early 2020 and accelerated to 6.2% year-on-year by February 2020. However, with the moderation of food and non-food inflation, year-on-year headline inflation decelerated and was recorded at 4.2% by end 2020, compared to 4.8% recorded in December 2019. The rates somewhat hovered around the single digit inflation targeting regime, a method, as we mentioned, brought in by Coomaraswamy. The Central Bank is yet to release the Annual Report for the year 2021. However, the chart below indicates the gradual growth in CCPI core inflation, CCPI headline inflation, NCPI core inflation, and NCPI headline inflation last year. NCPI headline inflation hit double digit rates as of November 2021, as shown in figure 1. Factors that led to double digit inflation rate in Sri Lanka The Sunday Morning Business spoke to University of Colombo (UoC) Faculty of Arts Department of Economics Senior Lecturer Dr. Shanuka Senarath to determine whether the gradual increase of inflation across CCPI and NCPI was mainly influenced by the same factors that led to increase in inflation in other countries. Senarath stated that the global inflation is soaring due to a number of key reasons, out of which the closest reason is the ongoing pandemic. He stated that the supply side is affected due to the pandemic. “If the supply of an essential good or service goes down given the demand remains the same, the prices go up. This can cause global inflation. If you look at the airline industry, the prices are very high. This is because of the supply side issues as not many airlines are flying at the moment or not at their full capacity,” he noted. According to him, in the global context, inflation persists mainly due to the supply side factors, when demand may not have declined, leading to a growth in inflation. However, he added that there is another side of inflation where a country is import reliant and their currency depreciates, and that this is the case in Sri Lanka. “Now, this is not common to all the other countries that are facing growth in inflation. Look at the Maldives, Thailand and other countries that depend on tourism. They do not record a depreciation in their currency as much as Sri Lanka. If I look at the Sri Lankan context, the inflation is coming from the demand factor. As in, we have an aggregate supply and an aggregate demand amidst a shrinking economy and this demand side has gone up with increased Government spending. This increased Government spending comes from excessive money printing,” he emphasised. “When the Government prints money and it is released to the public, for example through State projects, the printed money is somehow pumped into society, which creates a high circulation of money, which in turn formulates high demand for products. “Other factors include the depreciation of the Sri Lankan rupee. If the Sri Lankan economy is also expanding in proportion with the increased money supply, money printing would not be an issue as inflation might remain constant in this scenario. Inflation is not always a bad thing. A 2% increase in inflation annually is a must, in fact, but certainly not a 6% increase,” Senarath stated. He stated that in addition to this, the cost of production too has gone up, led by import restrictions and price hike in intermediary goods. Factors behind inflation not the same as other countries As pointed out by ruling party politicians, inflation across many countries is at their highest rate in decades. Inflation in the UK was at its highest rate in 30 years as of December, pressuring the Bank of England to raise interest rates again. According to Reuters, the annual rate of consumer price inflation increased to 5.4% from November’s 5.1%, the highest since March 1992. Economists polled by Reuters had expected a rise to 5.2%. However, this is due to a global rise in energy prices and supply chain difficulties. Meanwhile, Canada’s annual inflation rate accelerated in December to hit a 30-year high. Inflation rose to 4.8%, in line with analyst expectations and the highest print since it reached 5.5% in September 1991, Reuters quoted Statistics Canada. In this case too, re-acceleration in energy prices, transportation issues impacting food costs are cited as reasons. According to Xinhua, Germany’s annual inflation rate reached 3.1% in 2021, the highest level since 1993. However, the temporary reduction of value added tax (VAT) and the sharp decline in mineral oil products during the first year of the Covid-19 crisis had a strong upward effect on the overall inflation rate in 2021 were cited as the reasons. South Africa’s annual consumer price inflation hit 5.9% in December 2021 – the highest annual rate since March 2017, when it increased by 6.1%. The inflation rate climbed from 5.5% in November. According to News 24, prices of food and non-alcoholic beverages increased by 5.5% in the year to December, while transport prices jumped by a whopping 16.8%, fuelled by rising petrol and diesel prices. On the other hand, according to CNBC, Eurozone inflation hit a new record high in December, raising more questions about the European Central Bank’s monetary policy. Preliminary data showed that the headline inflation rate came in at 5% for the month of January, compared to the same month last year. The figure represents the highest ever on record and follows November’s all-time high of 4.9%. The increase was mostly due to higher energy prices. Meanwhile, in the US, inflation jumped at its fastest pace in nearly 40 years last month, a 7% surge from a year earlier that is increasing household expenses. The biggest driver of inflation, according to economists, are mismatches between supply and demand. Used-car prices have soared more than 37% over the last year because a shortage of semiconductors has prevented auto companies from making enough new cars. Supply chain constraints have driven furniture prices nearly 14% higher over the last year stated The Los Angeles Times. Turkey’s inflation climbed to a nearly two-decade high in December on the back of a weakening lira that is driving up the cost of food and other basic goods and destabilising the wider economy. Annual inflation rose to 36.08% last month, up from 21.3% in November, the Turkish Statistical Institute said. However, in terms of the Asian region, India’s benchmark inflation rate, measured by the Consumer Price Index (CPI) firmed up to 5.59% year-on-year in December 2021, data released by the Ministry of Statistics and Programme Implementation showed in contrast to higher inflation rates recorded by many developed countries in the west in decades. Challenges faced by the pandemic are cited as the reason for this five month hike in inflation. Pakistan’s consumer price index rose 12.3% in December from a year earlier, according to the country’s official statistics bureau. The Indian Express stated that the recent rise in oil price prices was the highest ever in the country's history, which is expected to lead to an increase in the cost of food items due to higher transportation charges. Based on the research done to determine the inflation rates of the other countries, the main factor that led the inflation to soar in these countries is said to be the increasing global oil prices whereas in Sri Lanka as Dr. Senarath puts out, demand related factors led to the current double digit rates of inflation. However, in order to contain the further growth of inflation rates, the Central Bank of Sri Lanka last Thursday (20) increased policy interest rates. Accordingly,the Standing Deposit Facility Rate (SDFR) and the Standing Lending Facility Rate (SLFR) of the Central Bank were increased by 50 basis points each, to 5.50% and 6.50%, respectively.

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Inflation is universal but factors leading to inflation aren’t

Inflation is universal but factors leading to inflation aren’t

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