31 October, 2020

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Economists Divided Over CBSL’s Decision To Increase Interests

By Hema Senanayake

Hema Senanayake

Hema Senanayake

There is a significant difference between scientists and economists. Both scientists and economists use certain methodologies when testing hypotheses in their respective fields of study. However, the end results differ vastly; in science dogmas cannot prevail but on the contrary dogmas prevail in the domain of “economic science.” Yet, this does not mean that we can ignore the importance economic science, instead it shows the necessity to remove dogmas from economic science which science that paves the way to thrive human civilization in each country and globally. I wrote this to point out that dogmas exist in using interest rates by the Central Banks as policy tools to steer the monetary policy in any given country and Sri Lanka is no different.

Recently, the Central Bank of Sri Lanka (CBSL) increased its two main policy rates and as a result the market rates of interest will go up sooner. On this decision economists are divided – And some economist hailed the decision while some others opposed it. It is on record that I did not support the increase of rates of interest; instead I support the idea of keeping market interest rates steady in mid-single-digits within normal periods of economic growth if the government does not intend to deflate systemic bad debt by a policy known as wage-increase-bound-moderate inflation. For an example, a study done in the U.S. has shown that if the minimum wage in the U.S. is increased by 75%, there would be a mild inflation of 2 to 3%. The impact of such a policy would be that it revive the badly weaken credit cycle by deflating the existing debt in general. This theory is not in the main stream yet but at least one U.S. billionaire has supported the idea from a different perspective by writing an article under the caption, “The Capitalist’s Case for a $15 Minimum Wage” from which article he demands to double the minimum wage.

However, when come to Sri Lanka, all economists agree that inflation must be contained and the widening deficit in the nation’s current account must be kept constantly under check within a desirable range so that there won’t be any negative pressure on the Balance of Payment. If there is a severe negative pressure on the Balance of Payment emanated from an increasing deficit of the current account now, even if there was no foreign debt obligation originated from Rajapakse regime, the country has to take foreign loans, if non-credit based inflow of dollars such as Foreign Direct Investments (FDIs) or foreign grants cannot be increased significantly.

According to the press release, the CBSL has increased rates in order to contain inflation and widening trade deficit and to support the Balance of Payment situation. Some economists and some analysts are jubilant over this decision but I am not because I do not believe that rates hike would not support to achieve the very goals mentioned in the CBSL’s press release. Therefore, I suggested using combination of novel policy and administrative tools through which the intended goals could be achieved while keeping the interest rates low and steady. The reason for my insistence is arising from a clear understanding that the present money-based system of economy has a severe contradiction and that contradiction cannot be simply mitigated by adjusting rate of interests and by floating the rupee.

On the contrary, my suggestion to the monetary authorities and other economists who work outside the establishment is to understand the nature of the system’s contradiction and develop comprehensive set of policy and administrative tools to steer the monetary system so as to achieve the economic objectives of the nation. Let me give you some clues in order for you to understand the contradiction that I am talking of.

When a household gets richer, it becomes debt free. Do you expect the same thing to happen when a country gets richer? You may say “yes”, but in general opposite happens. Not only richer countries accumulate vast amount of debt, they also accumulate the highest amounts of bad debt too. American economist Hyman Minsky explained that the nature of the capitalist economy is such that it accumulates enormous amount of bad debt as the economy grow and the economy would collapse if the bad debt is not expunged from the system. This was what happened when the U.S. economy and many large economies of Europe collapsed in 2008.

The contradiction is that, when the economy grows the amount of bad debt accumulated in the system increases instead of decreasing. Minsky put the blame on the risky speculators who operate in the financial market. On the previous point he is correct but on the latter point he was wrong. This is where I made an invention in 2008 by presenting a new hypothesis as follows:

“The contemporary economic system can never pay consumers an aggregate income that is equal or exceeding to the value of consumption.” If this is true, what impact it makes in the economic system?

According to the above hypothesis, the economic system is not in natural equilibrium of demand-and-supply and as such, consumers are required to consume beyond their aggregate income in order to have the economic equilibrium. When somebody or a system consumes beyond its income should it begins to accumulate bad debt. This is the reason to accumulate bad debt in the system and differ from Minsky’s perspective. By any chance if consumers began to practice minimalism which idea is promoted by young Japanese, the economy collapses. This means, we can’t live as we want as a whole community. The present system of monetary infrastructure is designed by people and the system we put in place cannot allow us to be debt free at any level of economic growth.

Managing such a system in order to ensure the best possible economic wellbeing is not that simple. When the CBSL does not understand the systemic behavior of the economy, the problem becomes more serious. Intended goals cannot be achieved by adjusting interest rates. Instead, we would achieve better results by keeping the interest rates low and steady, if you can address the issue of inflation, reducing of current account deficit and having good Balance of Payment situation, by employing more prudent set of policy and administrative tools. Ad-hoc measures some time work but not all the time and this proved recently by the U.S., Europe, Japan, Argentina etc. My advise to CBSL is that, do not look for success model/s, but look for right theory and do dare to innovate.

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Latest comments

  • 2
    0

    Raising interest rates is good because it rewards those who save and help grow the REAL ECONOMY, rather than the corrupt clowns who manipulate the stock market and make paper money!

    Question is why is the Govt. and Central Bank not asking World Bank and IMF to track down the billion of dollars looted by the Rajapaksa regime and cronies, stashed in off shore bank accounts to pay off the massive national debt?

    Is it because the funds stolen from the poor in the global south help expand the wealth of the global 1 percent whom the IMF and WB support?
    WB and IMF are supposed to be in charge of financial institutions and they should focus their work on the big illegal flows and global networks of corruption whereby funds from countries like Lanka and Greece are stolen and kept in off shore banks by local and global crooks and elites.

    Returning looted funds by the Rajapaksa regime through big white elephant infrastructure projects (and the Chinese )to Sri Lanka is the only and BEST way to solve the National DEBT CRISIS rather than forcing austerity on the poor and raising VAT and other taxes.

    All the studies that the World Bank and IMF does on local economic and social issues can be done better by the UN agencies and NGOs.

    The French govt. is now pressing charges against IMF head Christine Lagrand for corruption! The IMF and world Bank if they do now trace and recover funds looted from highly indebted countries should be SHUT DOWN. The Washington Consensus is anyway dead and these are expensive dead horse institutions that have contributed to generate the global financial crisis, economic inequality and poverty and wars on an unprecedented scale today.

  • 0
    1

    Good article!

    The corrupt Politicians of the Diyaweena Oya should be forced into giving up their SUPER LUXURY life styles, SUVs and trips to Singapore hospitals, and do some AUSTERITY for a change.

    It is not the poor of Sri Lanka who should have VAT and tax increases, it is the corrupt politicians who should be forced to cut their expenses.
    But Mahinda Jarapassa has been given a new house in Colombo 7 after he and his sons and brothers looted the country with Chinese white elephant project LOANS and piled on the national DEBT.
    Basil Jarapassas even stole from the poor – the Divineguma Poverty fund and should be givne double time in jail.

    What is Ranil Sira Ayahapalanaya doing raising taxes while politicians live in super luxury, fly to SIngaproe hospitals when they are ill and travel in SUVs? All this nonsense should stop.
    Rani-Sira should also stop its tangoing with IMF and its corrupt policies that force austerity on the poor rather return looted funds from Panama Papers?!

  • 2
    1

    Hema Senanayaka,

    As economy is a hypothetical science, the safest policy for interest rates to go middle path …..around 4-5% as you suggest. Guess inflation, wages, debt, bop, and interest rates are all variables, each to be adjusted when and if needed. We will trust in your novel policy and administrative tools(although you don’t specify them on CT).

    Guess the economic system’s contradictions in bad debt, lie in factors like having technology to teach and share with others, being friendly and wheeling and dealing with the right place/s, or having a rampant military machine,…..all in whims and fancies… But let’s hope our unique vegetation and ecological landscape is not going to be replaced with the monotonous greenery of oil-palms.

  • 3
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    What economists are divided over the CBSL move? I HAVE NOT SEEN A SINGLE ECONOMIST DIVIDED. Only some pseudo economist named Hema Senanayaka who nobody has ever heard of!

    Here are some useful reforms in CBSL bond trading in keeping with international norms:

    Sri Lanka Central Bank introduces reforms to bond trading
    http://www.lankabusinessonline.com/sri-lanka-central-bank-introduces-reforms-to-bond-trading/

    These are the kind of things we need. No need of Hema’s paradigm shifts and untried/untested tools that only Ramona Therese Fernando is fooled by! Of course expect an article by Hema very soon where he points out all the flaws in this latest arrangement as well!

    • 0
      1

      Nonsense. No need to sneer so much. All we need is some responsible lending, and the economic wheels will work quite well.

      Trouble is we are studying and following American economics, and America is in the business of creating money to sustain as they have no other way out.

      Sri Lanka, on the other hand, has plenty of natural and traditional resources and livelihoods to build up on, but current GoSL has no regard for Lankan common man expertise. Utilizing common man expertise is of course a process of far greater complexity, and they have little patience and patriotism towards it.

      They see the grandeur in tall skyscrapers of S’pore and M’sia, and strive to whip up the people to fulfill those skyscraper ambitions. You must be an oil-palm tycoon, waiting to translate oil-palm money into skyscrapers after destroying the beauty of the Lankan natural and ancient landscapes for these dreadfully boring trees.

  • 3
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    The money supply must be reduced. Savings mean low consumption. Let us reduce credit card debt controlled by credit companies.

  • 3
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    Hema Senanayake seems to think that by lowering interest rates, banks will borrow cheaply and then lend out cheaply to people in order to ‘spur growth’ Hema Senanayake clearly has no clue how the banking system in Sri Lanka (or anywhere else for that matter) works, and would best keep his theories confined to his personal dustbin.

    Banks borrow low and then reuse that money for their own trading portfolios, or make only slight or insignificant decreases to their lending rates. This ensure that in today’s overcompetitive Sri Lankan banking sector they still make these crazy “100%” YoY growth rates that we see. The number of people borrowing is not increasing, only the cost at which they are borrowing. In addition, we saw how beautifully reducing rates squeezed the margins of banks in the USA, who were then compelled to enter into the most toxic of assets, even issuing loans to dead people, in order to meet targets in an environment where they were no longer competitive.

    Raising the rates ensures better quality loans and practices by the local banks. In addition, it reduces the chances of people borrowing beyond their means. Savings now will be good for (if and) when the economy is in better shape – right now we are importing far too many things. These are basic principles, no need to any textbook theories [Edited out]

  • 1
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    Well over a million Lankans are slaving in the Middle East remitting what they save towards retirement. The hard currency is used by politicians to get themselves limousines, arms to protect themselves, visits to Singapore for trivial medical reasons and so on. The savings of the expatriates keeps eroding. They must be rewarded and one obvious way is through higher interest on savings.

  • 0
    0

    How about introducing a moratorium on the use of credits cards? Set a limit and that limit should be based on the disposable income of the person. Also, do not increase the credit limit, just because the card-holder pays the minimum balance. I am not an economist so I welcome comments. But I venture to think that debts of ordinary citizens will be better managed and fiscal controls will be practiced.

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