Inflation, Interest Rates and Economic Depression

Inflation seems to be the only major concern for the economic policymakers shaping Sri Lanka. They include the Central Bank, the Finance Ministry, and the IMF. An economic depression is underway in the country with tremendous disruption of livelihoods, mass unemployment, and collapsing businesses. The GDP contracted by a tenth last year and it is likely to contract in similar proportions this year. But all this is of secondary concern to the economic establishment.

Austerity policies and the Central Bank policy rate, which was increased from 6 percent to 15.5% a year ago to satisfy the IMF recommendations, have strangled the economy. Given that the economy is grinding to a halt, the worst thing to do is what the Central Bank has done with its announcement of another interest rate hike of 100 basis points, increasing the policy rate on March 3, 2023 to 16.5%. 

The policymakers’ push for economic contraction, which they justify in terms of satisfying the IMF, and the IMF’s rationale, which it articulates as fighting inflation, are democratically unaccountable, economically flawed and merely meant to serve the long-term interests of global capital. The suffering of our people, who are being pushed to starvation, is merely reduced to collateral damage by our comprador elite and their masters. The IMF is the voice of the latter, and the guardian of global capitalist interests.

Central Bank’s position 
The Central Bank of Sri Lanka is no longer independent. It constitutes a clear and present danger to the country as an agent of the IMF. This is what the Monetary Board of the Central Bank had to say in its statement on March 3, 2023:

“Given the necessity of fulfilling all the ‘prior actions’ in order to move forward with the finalisation of the IMF Extended Fund Facility (EFF) arrangement, the Monetary Board and the IMF staff reached consensus to raise the policy interest rates, in a smaller magnitude, compared to the adjustment, which was envisaged during the initial stage of negotiations.

This decision demonstrates Sri Lanka’s commitment to the IMF-EFF arrangement, which has been pursued by the Government in order to ensure stability in the economy on multiple fronts. The finalisation of the IMF-EFF arrangement is expected to benefit all stakeholders and bolster confidence, which would help restore stability in the economy on a sustained basis. This will incentivise more foreign exchange flows in the period ahead that would aid the economy to overcome the prevailing economic crisis. The Board was of the view that the economy has already traversed through the most difficult and unprecedented times with tremendous resilience and strongly believes that today’s decision would pave way for a faster-than-expected deceleration of inflation.”

I quote this statement at length because it illustrates the inability of Sri Lanka’s policymakers to think in the interest of the country, and how they blindly cow down to the demands of the IMF. More importantly it is evident of the lie about controlling inflation that is told to the public, even though it is about serving the class interests global capital. Indeed, while the statement above talks about higher interest rates to “incentivise more foreign exchange flows in the period ahead”, in reality, it is merely about remaining in the good books of global finance capital. Following Sri Lanka’s premature default, which I have explained in recent writings, there is little chance of market oriented global financial flows into the country anytime soon. 

The high levels of core inflation in Sri Lanka reaching 60% and food inflation reaching 90% over the last year was caused by a one-time change in price levels due to the sudden devaluation of the rupee from Rs. 200 to Rs. 360 per US$. Thus, the price of all imports into Sri Lanka rose by 80% over night, even as the Government did little to subsidise even essential goods. In fact, in tune with the IMF recommendations, at that very crucial moment of price hikes, the Government cut any subsidies that existed. For example, market pricing of fuel has led to a three- to four-fold increase in the price of petrol and kerosene. Sri Lanka now consumes about half the amount of fuel compared to a year ago, which is contributing to the tremendous contraction and economic depression. In addition, in the months after the start of the war in Ukraine a year ago, there were price increases in global commodity markets, which worsened inflation levels all around the world. The passing on of such price increases also contributed to the extremely high inflation levels in Sri Lanka.

Inflation, however, is calculated year-on-year. Therefore, given that price hikes, dubbed as inflation, took place mainly between March and September last year, inflation levels in Sri Lanka are likely to decline steadily starting March this year. If there are no further shocks, it may well reach very low levels after September this year. The Central Bank dishonestly claims that it is its policies that are reducing inflation, when the logic of the calculation of inflation year-on-year should be apparent to the Central Bank’s policy makers and any economist with a bit of brains. Furthermore, even if inflation comes down to single digits later this year, it means nothing to the working people because there has been a one-time tremendous increase in the cost of living without a corresponding increase in nominal wages. Hence in the absence of any wage increases in the near future, the state of tremendous wage repression will continue with the fall in real wages by as much as 40% due to the cost-of-living increase. In other words, real wages will remain at that low level, even if official year-on-year inflation levels come down to zero later this year. 

Global capital interests
What these extremely high interest rates in fact do is slow down the economy. Small producers and businesses are unable to borrow working capital, as commercial banks pass on the interest rate hike. Loans for production are now near 30%. Accordingly, many small producers and businesses are either stopping production or going bankrupt, devastating livelihoods and throwing people out of jobs. Such dispossession in turn reduces the bargaining power of labour, so that tremendous wage repression can be maintained. 

The recent protests by the professionals against the Government for the income tax increases for those earning more than Rs. 100,000 per month, has now discovered a reality check as IMF officials have gone on record defending such taxes. Now, Rs. 100,000 per month for a family of four amounts to about US$ 2.30 per person per day, a level just above the World Bank’s line of extreme poverty set at US$ 2.15 per person per day. Furthermore, the rise in interest rates has meant that personal loans that professionals had taken to build a house or buy a vehicle few years ago, now require much higher monthly payments. For example, ten-year loans of say Rs. 5 million or Rs. 10 million will require additional monthly loan payments of Rs. 20,000 or Rs. 50,000 per month respectively, reducing these households’ disposable incomes by that much, even as cost of living has increased by 60%. The professionals are rightly up in arms against the Government, but they are yet to realise that those dictating the terms of their misery is the IMF.  

This policy of high interest rates to curb so-called inflation is not only being applied in Sri Lanka. Since the neoliberal turn, and rise of the class project of finance capital, inflation is seen as the enemy to be defeated by global capitalist interests. The long economic downturn of the 1970s was solved in the interest of capital by the massive interest rate hikes introduced by Paul Volker of the Federal Reserve of the United States, earning the name the “Volker Shock’, which initiated an era of much higher returns for finance capital. Furthermore, when there are higher levels of wage inflation – which is not the case now – even if it can be sustained in line with economic growth, it is opposed by the hegemonic policy makers because the returns to capital decrease. This orthodox doctrine of maintaining low inflation with high interest rates has become so entrenched that economists who curry favour with the establishment dare not challenge it. 

The world has been reconfigured to serve global finance capital over the last four decades. The global crisis underway is a fight over the question, who pays for the crisis? Will it be capital or labour? And in this great battle for the future of the global political economic order, the suffering and even starvation of the Sri Lankan people is of little concern for the IMF and for that matter the great powers that control it. If the citizenry of this country doesn’t realise these dangers amidst the economic depression, and if we continue to accede to the dictates of the IMF, we are only digging our own graves.