Inflation fears could spook markets as lockdowns wreak economic havoc

Inflation fears, which are already making their presence felt in the consumer and supplier markets since of late could accelerate, perhaps even prompting the Monetary Board to take its foot off from the gas pedal ending the current stimulus. 

Sri Lanka’s consumer and supplier prices accelerated since lately, as consumer spending surged after an year of being sheltered-in-place, due to virus fears amid record money printed by the Central Bank to provide the much-needed monetary stimulus to support the pandemic-stricken economy last year, stoking some concerns of demand-side inflation in recent months. 

Import controls, which were also brought into support the local producers, have also started to pinch the consumer the most, as oligarchs and unscrupulous local businessmen are making super profits at the expense of the hapless consumer, as controls on imports greatly limit consumer choice.  

Credit rating agency ICRA Lanka Limited has cautioned about fresh concerns on prices that could stem from disruptions to domestic supply chains triggered by the highly destructive restrictions on the economic activities, which were imposed for the third time, citing COVID. 

“Pandemic-induced supply shocks together with import controls may further fuel inflation fears,” the rating agency said. 

These price pressures it said continuously push the treasury yields higher in the near term, as the bondholders might keep factoring the inflationary fears into their yields. 

When there are signs of inflation, bond yields rise as investors demand for higher yields, which can beat inflation.
During April, according to ICRA Lanka, the yields in the one-year bills saw them inching up by about six to seven basis points while in the secondary bond markets, the yields edged up across all three maturities – three months, six months and 12 months by 12 basis points, 11 basis points and five basis points each. 

Headline inflation in the Colombo district rose by 3.9 percent in the 12 months to April 2021, easing from 4.1 percent in March 2021, albeit the food inflation was rising consistently at closer to double-digit levels, although the non-food inflation remained just below 2.0 percent.

Meanwhile, the Central Bank considers the current inflation is transitory and will not be persistent and it is still within its desired band of 4 to 6 percent. And the Central Bank in April said it would not hesitate to pull back from the stimulus, if any excesses emerge from the unprecedented level of monetary support unleashed on the economy since the onset of the pandemic in March 2020. 

While the inflation fears mounted leading up to the new year holidays, there is already a possibility that the demand-side price pressures could subdue post-new year, due to the current restrictions on consumer activity by the authorities due to fears of virus spread, possibly negating the price pressures that could come from a supply-side shock. 

However, sustaining the workforce, specially a bloating 1.6 million state sector employees, who have now been asked to work from home, ignites inflation when they contribute to negative productivity.