Inflation, a general increase of overall price level, is more of a global phenomenon that carries a dual face as it can be mostly a harbinger of economic disaster as well as a welcome resource mobiliser that would be instrumentalised by policymakers for infusing economic dynamism in a dormant economy.
Albeit some positive results generated, inflation has caused economic mayhem and disappointment to the lower and the middle strata of the population, the fixed income earners, in the context of Sri Lanka especially with the beginning of 2021.
The main objective of this article is to critically examine the factors that contributed to the exponential rate of increase in the country’s rate of inflation during the past two years in the light of theoretical underpinnings and the behavioural trends of national economic parameters.
Inflation and its structural composition
In Sri Lanka, the rate of inflation is mainly calculated on the basis of the Consumer Price Index (CPI) which consists of two main expenditure categories such as food Items (41 percent) and non-food items (59 percent). Food items encompasse bread and cereals (8 percent), fish and sea food (6 percent) and vegetables (6 percent). Among the non food items, the salient expenditure items include housing, water, electricity, gas and other fossil fuels (24 percent), transport (12 percent), and restaurants and hotels (6 percent).
According to the Annual Report of the Central Bank, the headline inflation, as measured by the year-on-year change in the National Consumer Price Index (NCPI, 2013=100) increased to 58.9 percent in June 2022 from 45.3 percent in May 2022. This increase in annual inflation was driven by the monthly increases of both food and non-food categories. The monthly increases reflected in the annual average rose in food inflation to 75.8 percent in June 2022 from 58.0 percent in May 2022, while non-food inflation increased to 43.6 percent in June 2022 from 34.2 percent in May 2022.
The monthly change of NCPI recorded at 10.91 percent in June 2022 due to price increases observed in items of both food and non-food categories which were 7.25 percent and 3.66 percent. Within the food category, prices of rice, vegetables, fresh fish, sugar, milk powder and dried fish recorded substantial increases during the same month. Within the non-food category, considerable increases were recorded in prices of transport (petrol, diesel and bus fare), furnishing, household equipment, routine household maintenance, restaurants and hotels anent sub-categories during the same time period.
As regards inflation, it is noteworthy to keep in mind that many countries in their fiscal management policy, incline to maintain an average annual interest rate of inflation within the range of two to three percent with the emphasis placed on ensuring economic stability in the long run.
Theoretical perspectives
Inflation, as promulgated by economic theory, can be caused by demand driven forces (demand pull) or forces stimulated by the high cost of production outcome of which is reflected in the overall level of price escalation irrespective of what caused the inflation. Once inflation sets in and gathers momentum, it is rapidity reinforced by the nucleus forces as well as by external factors that are beyond the control of inflation infected countries. Even if inflation recedes its velocity and magnitude after inflicting its toll, it is very unlikely that the increased price level would return to the pre-inflation status as price increases are very often rigid downwards.
Demand driven inflation is observed in situations where demand for goods and services increases in leaps and bounds due to multiplicity of reasons ranging from sudden increase in population, unprecedented expansion of consumer preferences, unrestrained expansion of money supply and windfall increase of income in the low income stratum of the population.
Demand driven inflation can occur resulting from the influence of a single factor or as a combined impacts of all the factors cited above that produce synergetic acceleration of price level.
Anent the high inflation rate in Sri Lanka, any logical investigation is very unlikely to conclude that its origin is rooted in the demand driven theoretical frame and to find a cause and effect relationship between inflation and demand related factors since the major forces that propel such a situation were not visible, except the phenomenal increase in money supply, in the economy during the reference period.
On the contrary, during the period of economic turmoil, what can be observed is a continuation of the demand mainly for agricultural products such as rice, vegetables and eggs while supply of those items declined exponentially due to the mismanaged transition effort to convert agriculture into carbonic agricultural practices. The decline in supply of agricultural crops including rice, the staple food of an overwhelmingly large segment of the population, activated the natural play of supply theory in the face of uninterrupted perpetuation of consumer demand.
In the face of declining production, unscrupulous traders who are always ready to fish in troubled water, substantially contributed to the price spiral by hoarding large stocks of food stuff and forming themselves into sort of cartels for the obvious purpose of mechanisation of free market mechanism in favour of their business interests. Axiomatic evidence for confirmation of those facts can amply be found, inter alia, in the trading practices of rice, eggs and bakery products, producers of which are well organised to manipulate free market demand and supply forces in favour of achieving their parochial business goals.
The main supportive argument that can be brought forward anent that the inflation is a demand driven phenomenon hinges upon solely on a single factor relating to the unprecedented increase in money supply due both to money printing and borrowing by the Government for bridging its current account deficit.
Cost-push scenario
Price increases in main consumer items during the past two years appear to be unusually rapid so that naming the two years, 2021 and 2022, as annus horribilis may not be an exaggeration or blowing the actual situation out of proportion in view of economic and the pandemic disaster faced by the country.
For example, consumers who bought eggs below Rs. 20 each were compelled to pay more than Rs. 75 one year after, a kilogram of rice that was sold below Rs.60 in 2021 went up to Rs. 180 per kilogram in 2022, even a hundred gram of fried peanuts sold at Rs. 60 a few moons ago was increased to Rs. 200 in 2023 which in percentage term of increase represents an exponential upsurge within two years. The price behaviour of other commodities exchanged in the market followed a similar lineage with minor deviations right through the period, which drived the masses virtually to the tether’s end in their daily struggle for existence.
The above examples, albeit a few in numerical terms, represent the overall trend of price movements in 2021, 2022 and the current year with major upward trends and minor downward movements that made living harsher and harder for the majority of the country’s population. Parellel to the price increases of commodities, a substantial increase in the prices of diesel, electricity, fertiliser and agrochemical were also reported during the same reference period showing the existence of a possible co-relationship between the price increases of consumer commodities and the upward trend in the prices of energy and other manufacturing inputs that impelled the cost of production uphill.
In particular, diesel, fertiliser and electricity price increases have become a centrifugal force that pushed up the prices of comestibles of different type during the period of the past two years. Statistical evidence for substantiating the related link can be amply cited from the authentic data sources such as the Annual Report of the Central Bank, Department of Census and Statistics and the academic research conducted by freelance researchers.
The recent exponential price hikes in power and fuel are such that even the middle class families are compelled to give up the comfort of enjoying hot water shower, adapt to manage with one electric bulb in the night for want of keeping the electricity bill withing the affordable limit. Even in the case of private vehicle users, many individuals and families in the middle class who own motor vehicles reluctantly get used to travel by public transport to safeguard their wallets from depleting in the face of unbearable price increases.
Nevertheless, some social segments, in spite of the deteriorating real income level in the face of escalating price levels, have been blessed with the fortune of maintaining their opulent and sybaritic lifestyle defying the cognizant ability of the suffering majority how such behaviour can financially be supported. Similarly, firms and individuals engaged in the production of essential items ranging from comestibles to intermediary material that goes into production of consumer goods, have been compelled by the circumstances to increase their selling prices due to the escalation of production costs on the one hand and the unscrupulous nature of business owners who are engaged in capitalising on the opportunity to earn windfall profits as their conduct is governed by the concept of Homo economicus on the other hand.
Energy prices have shown an acute upward surge in 2021, 2022 and 2023 that produced a cascading effect in numerous spectrums of economic activity which resulted in skyrocketing prices of vegetables, eggs, chicken, fish and all the other consumer items that are daily in demand. A cursory glance at statistical data anent diesel, electricity, fertiliser, labour prices, to name a few, provides convincing evidence and a criterion to establish a parallel relationship that continued to function in cohort with inflation and price increases of production inputs.
One is intrigued to believe after scrutinising pricing strategy of fuel and electricity over the past few years, whether policymakers have considered the sources of energy, in particular fuel and electricity, only as the scoopers that help government replenish the dwindling revenue of the treasury.
The other cause leading to the cost escalation is related to the declining par value of the local currency as against the US dollar since depreciating rupee value leads to the price escalation of imported comestibles, intermediary products and all the other imported commodities in cohort with ever increasing exchange rate. Since the bulk of food commodities of daily consumption is currently imported from abroad, the influence of the exchange rate increases on the consumer price index and hence level of inflation cannot be underestimated in the prevailing economic circumstances.
Identical products
The abnormal and unwarranted increase in production cost pertaining to locally made agricultural and manufacturing commodities might lead the whole economy into a more hazardous catastrophe since political decision makers may be compelled to arrive at decisions for importing identical products from abroad at a lower cost, inclusive of shipping, insurance, warehousing and transaction cost, under the pressure of mass agitation on the streets against the skyrocketing prices of essential commodities.
The recent hullabaloo and the public debate observed in the media on the possibility of importing eggs from India and selling them at a lower price than the prices of locally produced eggs is an indication of the brewing economic and political trend in the country which may be spanned over the other comestibles such as chicken, fish, vegetable, potato and union that are supposed to be comparatively cheaper if imported, compared to the prices of the locally produced homogeneous items.
Albeit the possibility of inundating the local market with relatively inexpensive imported products, the long-term repercussions of such a course of action will make the solution penny wise and pound foolish due to the cascading catastrophic effects it produces on the livelihood of millions of people engaged in production of such commodities in relation to their employment, survival and disruption of entire social status quo.
There is no consensus among academicians and policymakers as to whether the priority should be given to riding inflation for resource mobilisation or controlling the inflation for achieving economic stability thereby ensuring the maintenance of civil obedience and law and order of the country.
If the country desires achieving sustainable development in a foreseeable future, then it is essential that local production capabilities must be strengthened by way of providing electricity, fossil fuel and other basic utilities that are used in both agricultural and manufacturing sectors at reasonable prices enabling domestic producers to enjoy comparative advantages through low cost of production vis a vis the foreign manufacturers of similar commodity.
Another factor contributing to the cost push scenario is the high cost of capital inflicted due to high rate of interest charged by the commercial banks thereby allowing interest rate to determine the lowest ceiling of profits that should be maintained by all business enterprises to avoid higher opportunity cost of investment. The final outcome of those factors and their interplay is the accelerated rate of inflation showing the prices going through the roof as far as people are concerned.
What the country required is the formulation of a production facilitating and stimulating pricing strategy for fossil fuel, electricity and other inputs on a priority basis rather than engaging in political nitpicking.
The outcome of such policy strategies assures two pronged results such as deceleration of inflation on one hand and minimising the threat to the local producers posed by the impending political decisions facilitating the import of cheap comestible to pacify the rising anger and agitations of masses against inflation.
The predictable outcome of sharp increases in production cost, as it can be seen today, is the positioning of Sri Lanka as a “high-cost production”country compared to the peer group countries in Asia, in particular Vietnam, Bangladesh, Thailand, India and many other developing countries.
If the supply side economics is brought into focus, one can find axiomatic evidence to support the above argument since cost of production anent chicken, eggs, chillies, vegetables, garments, potato, unions, to name a few, is much higher in Sri Lanka so that import of such comestible makes a viable economic option in terms of comparative advantages associated with it.
However, this path essentially ensures economic annihilation of the country in the long run and furthermore; it is worthwhile to note that no country has archived sustainable economic development through the implementation of such policy strategies.
The writer is the former Senior Consultant of the Sri Lanka Institute of Development Administration.