By W A Wijewardena –
Aseni, whiz kid in economics, has learned that Prof. G.L. Peiris, a breakaway Parliamentarian from the ruling SLPP, has severely criticised the gazette notification issued by President Ranil Wickremesinghe as the Minister of Finance temporarily suspending about 1,200 different items of imports. His claim has been that by including inputs, machinery, machinery components, and digital equipment like computers and phones, the Government has severely hampered the smooth working of all the three major sectors of the economy. This has been fatal for Sri Lanka which is now struggling to put the economy back to the positive region from its negative trend. Aseni asks her grandfather – Sarath Mahatthaya or Mr. Sarath – about this.
They are in conversation on economics of President Ranil Wickremesinghe, tagged Ranilnomics.
The following is the second part of the conversation between the two of them:
Aseni: Earlier in August, President Ranil Wickremesinghe had issued a special gazette notification temporarily banning about 1,200 odd import items. This has been severely criticised by Prof. G.L. Peiris who was a minister in the previous SLPP administration. Given these deficiencies, why did the Government ban those items?
Sarath: There is an economic rationale behind this temporary suspension.
Before coming to economic rationale, I would like to bring to your notice some grave aspect relating to this temporary suspension. That is, there is no exit time for the new measures. Therefore, the danger is that they may become permanent just like the exchange control which was introduced by the British rulers as a war time strategy in early 1940s. After gaining independence, the Government of Ceylon was expected to abolish it, but to the dismay of many, it was continued. Similarly, the present grave foreign exchange and economic crisis might compel the Government to keep these temporary measures for a long time making them permanent at least in the next few years. That is a danger which should be avoided.
I can explain its economic rationale in the following way. The present rising inflation in Sri Lanka is due to the aggregate demand exceeding the aggregate supply. The aggregate demand in the economy is the total demand for consumption goods like foods and non-food items and for investment goods like machinery, building materials, trucks, buses and so on. When this demand is more than the supply, just like a car that is being accelerated beyond its capacity, the economy gets overheated resulting in inflation. In this situation, to curtail the aggregate demand to match the aggregate supply, the Central Bank adopts restrictive monetary policies in the form of increasing the interest rates and curtailing credit supply. Those policies are called demand management policies because their objective is to manage the aggregate demand to be equal to aggregate supply.
In a normal situation they work. But when the inflation is rising at very high levels as in the present case in Sri Lanka where inflation is rising at about 60-65%, the traditional demand management policies don’t work. It is like a man who has got a heart attack not responding to conventional curative treatments. In this case, the doctors try to cure the patient by resorting to unconventional treatment methods like ‘shock treatments’ by applying a mild electric pressure to reactivate the dead heart. But that treatment should necessarily be for a very brief period. If it is applied continuously, the patient will die not of heart attack but of getting electrocuted. Hence, a competent doctor knows by how much and how long the shock treatment should be applied. Too much of shock treatment will kill the patient. Too little of shock treatment won’t cure him. Therefore, it should be the right level of shock treatment.
Aseni: But how does this shock treatment example relate to the excess aggregate demand?
Sarath: It is very simple. When the aggregate demand doesn’t fall in response to Central Bank’s conventional monetary policies, the Central Bank will have to force curtail the aggregate demand. That is being done by directly intervening in the market. In the case of the credit market, the Central Bank may impose the maximum credit levels. Governor Warnasena Rasaputra did this in early 1980s when the inflation rate was rising above 20%. He placed a ceiling on the maximum level of credit levels of commercial banks to curtail the money supply growth, the main contributor to the rise in the aggregate demand. This did the trick and the inflation rate fell to 1.5% by 1985.
In the same way, the present temporary banning of many import goods is a shock treatment adopted by Sri Lanka authorities. Since it denies the availability of these goods in the market, the people will be forced to forego the use of these goods. It is forced curtailment of the aggregate demand which is a necessity today. From that point, it is a shock treatment.
Aseni: My teacher tells me that there is another role which these bans of imports play in the economy. She says that they are imposed to curtail imports, reduce the trade deficit, and finally help Sri Lanka resolve its present balance of payments crisis. Is there any truth in that argument?
Sarath: Yes, there is. The current trade deficit in Sri Lanka is about $ 8 billion per annum. These relate to imports and exports which we can see and therefore called ‘visibles’. In addition, there are payments in and payments out of Sri Lanka relating to service, called invisibles, payments on account of salaries, interests, rents, and interest, called incomes with respect to factor services, and remittances in and remittances out. All these taken together with visibles are called the current account of the balance of payments. This current account represents a country’s earnings and payments in foreign exchange. If payments are more than receipts, there is a deficit in the current account and that should be financed by generating a surplus in the receipt of capital, loans, foreign direct investments, and other receipts. If it is not sufficient to meet the deficit in the current account, the country will have to use its foreign reserves to finance the same. When reserves decline, it puts pressure for the exchange rate to depreciate.
Sri Lanka is in this position and banning of imports will help it in a small way to reduce the deficit in the current account and the need for using foreign reserves to finance the balance of payments deficit. But you will see that there are many other holes through which foreign exchange is leaking out of the country. Without plugging these holes permanently, Sri Lanka cannot have a permanent solution to its foreign exchange problem.
Aseni: I understand it now. These forced curtailments are just temporary palliatives for the much-enlarged balance of payments problem in the country. The permanent solution comes by increasing exports and other earnings. How does the temporary ban of the imports involved affect the country’s ability to earn foreign exchange?
Sarath: That depends on the type of goods that are banned. If they are pure consumption goods, then, the economy’s sacrifice is much less than when there is a total ban. If these consumption goods can be produced within the country, then, the loss is very temporary because they can be supplied to the market quickly. But if they involve capital goods, then, the economy’s sacrifice is prolonged. That is because the ban adversely affects the country’s ability to produce more. Hence, that impediment created by the Government will reduce the production of not only the domestically consumed goods but also those produced for the export market. It reduces growth, employment, and incomes, on one side, while increasing poverty, on the other. This should necessarily be a grave concern for the authorities.
Aseni: Are there goods belonging to that category in the list of banned imports?
Sarath: There are. There are spare parts, machinery, and inputs used in industry amongst the banned items. Professor Peiris has referred to this aspect of the banned items. He specifically mentioned about the banning of ball bearings, air compressors, and digital equipment like computers and mobile phones. He demanded the Government to review the list again and amend it. Fortunately, the Government has listened to these concerns and amended the gazette permitting some of these items. That is a good sign because the previous Gotabaya Rajapaksa administration stubbornly refused to listen to public concerns. This was evident when he had tried to convert Sri Lanka’s agriculture to organic overnight by banning the importation of chemical fertilisers and pesticides. The cost of that short-sighted policy is still being felt by Sri Lanka with a low output in all agricultural crops and reduced incomes of farmers.
However, there is still a shortcoming. The amended gazette has permitted only some of the inputs. Until all the inputs, spare parts, and capital items are permitted, its adverse impact on growth, income and employment creation, and poverty reduction cannot be avoided.
Aseni: But Grandpa, you said that even Governor Rasaputra had resorted to this type of forced curtailment of the aggregate demand by placing a ceiling on the credit levels of commercial banks. Didn’t that affect the economic activities?
Sarath: But Governor Rasaputra did it only as a shock treatment. Those credit ceilings did not apply for investment loans and confined only to consumption loans. He introduced two innovations to mitigate the adverse impact of the shock treatment. One was that he got the staff in the Money and Banking Division of the Economic Research Department to prepare a national credit plan to allocate the restricted credit for the priority sectors. The other was the seamless conversion of the credit ceilings based monetary policy to market based monetary policy. However, both were interconnected.
The latter involved the controlling of what is known as the monetary base or reserve money. This reserve money creation is nothing but what the ordinary people or even politicians call money printing by the Central Bank. Under the monetary policy strategy followed by Governor Rasaputra, you decide on the appropriate level of reserve money. Based on that you also decide on the permissible credit levels for banks. That credit level is then allocated for priority sectors under the national credit plan. This was how Governor Rasaputra did away with the initial shock treatment. He didn’t allow the ripples of the shock treatment linger in the system longer than necessary.
Aseni: That is wonderful. Did Governor Rasaputra conceive the idea of this national credit plan?
Sarath: No, that was in fact borrowed from Reserve Bank of India, the central bank in that country. But Sri Lanka’s officials had innovated that plan by combining it with the annual monetary policy targets based on the permissible reserve money levels. Commercial banks were told in no uncertain terms that they could not exceed those credit levels because they were the levels permitted under the Central Bank’s monetary policy goals set at the beginning of the year. The plan was announced after having detailed consultations with the relevant commercial banks before the beginning of the year. After that, it was followed up quarterly to see how far the actual credit levels have deviated from the plan’s targets. But Governor Rasaputra’s successor did not want to continue with the national credit plan because by that time, the necessity for such a plan had also died away. Hence, it was just one time experiment.
Aseni: What this means is that the Central Bank and the Ministry of Finance can introduce shock treatments to address an acutely grave situation. But those treatments should not be a permanent feature. In the case of the restrictions imposed on almost all imports, it is essential that the Government should review them and make amends to the undesired bans imposed. Thus, the list should be changed immediately to avoid its adverse repercussions.
Sarath: Yes, you are correct. Finance Minister Ranil Wickremesinghe should get his officers to review these items immediately and remove all the capital items and spare parts from the list. Otherwise, its cost will be much more than the cost of the short-sighted organic farming policy. Organic farming affected only agriculture. This list of banned items will affect all economic activities. It will impede economic activities, increase poverty, cause job losses, and make everyone poorer than before. This is a consequence that should be avoided at all costs.
Aseni: My learning outcome of this discussion is as follows. Conventional monetary policy involving interest rate hikes and money supply growth controls fail when there is high inflation as is the case in Sri Lanka today. In these circumstances, non-conventional measures like direct intervention in the economy should be applied. They are called shock treatments, but those shock treatments should not be continued for a long time. There should be a pre-announced exit time for these shock treatments.
The present temporary banning of imports of all kinds is a shock treatment. Its objective is to force curtail the aggregate demand to match the aggregate supply. They also help a country to reduce the trade gap, deficit in the current account of the balance of payments and relieve the external sector of the acute problem of falling foreign reserves. But it is important to adopt measures to mitigate the adverse impact of these bans. In the present case, the Government should review the list of items that have been banned and remove spare parts, capital items, inputs for production from the list to avoid a prolonged economic recession.
Sarath: Yes, this should be the main elements of what we call Ranilnomics, the economics of Ranil Wickremesinghe.
*The writer, a former Deputy Governor of the Central Bank of Sri Lanka, can be reached at firstname.lastname@example.org