Since the onset of the pandemic the economic theories of John Maynard Keynes are seeing a revival. Several variants of Keynes’ theories, now called post-Keynesianism, an eclectic mix of ideas that remained in the fringes are now creeping into the mainstream. One of the most popular such post-Keynesianism concepts is Modern Monetary Theory, and some economists, including those in Sri Lanka’s Central Bank and the Bureaucracy are suggesting this be the policy.
But what is MMT? and what are the implications of its adoption on the economy, businesses and ordinary people? Two of Sri Lanka’s top economists, former Central Bank Deputy Governor W A Wijewardena and Deshal De Mel, Research Director at Verite, a think tank, joined us to dissect what MMT is.
MMT theorists are convinced that if monetary policy is not generating enough investment then it is incumbent on the fis- cal authorities to make use of the low interest rates and run a high budget deficit
Could you explain Modern Monetary Theory, and what is your view on it?
Wijeywardena: Central Banks world over including in Sri Lanka follow Monetary Theory, so I believe they do not necessarily follow Modern Monetary Theory. The main feature of monetary theory is ‘money’. Money is a notion in our head with no real existence. It helps us to exchange goods and services for consumption or can act as an input for production. To say it simply, money is a facilitator.
Thus, when money is treated according to how Central Banks currently practice monetary theory, which is to print more money than necessary, it leads to higher prices of real goods and services, or inflation. When inflation sets in, an economy encounters major complications. For example, people will only focus on the present but not the future, resulting in a decrease in investments and an increase in interest rates. At the same time, foreign currency exchange rates will start depreciating resulting in a savings crisis. Monetary Theory tells us that Central Banks opt to print money because they have a monopoly over the production, or supply, of money.
This monopoly power must be used carefully and responsibly, and we are getting a fine lesson on how this is done today. Sri Lanka’s Central Bank recently started practising ‘monopoly power’ as they were following a new monetary policy platform known as ‘Inflexible Inflation Targeting’, under which money will be produced only to the extent it is necessary for the economy
Modern Monetary Theory is a breakaway group from mainstream economics, and it has no connection with Monetary Theorists although their wisdom was drawn from the old Keynesian economics. In 1936, John Keynes proposed that the government can print money and use that printed money to help people purchase goods and services, thereby aggregate demand will increase in the economy, and along with the increase in aggregate supply, Keynes outlined the birth of economic prosperity where employment will prosper. Keynes never expected his theory to work in an open economy and in fact, his theory failed under such conditions.
There were various breakaway groups referred to as ‘Post Keynesian’ and ‘Modern Keynesian’, along with an addition of a new group known as ‘New Keynesian’, who introduced the concept of Modern Monetary Theory. Unfortunately, even today, there are many economists still advocating this theory in developed economies in the West as Modern Monetary Theory. They still believe that printing money will cure all economic ills.
Most recently, Stephanie Kelton, who advised former U.S. senator Bernie Sanders on economic policy, argued in her book Deficit Myth that the economic problems of the world can be solved by printing money; from poverty alleviation to income redistribution to protecting the environment. The promise of Modern Monetary Theory, or printing money, is sweet music to the ears of politicians and policymakers, especially in the developing world; this is because printing money is easier than working hard to raise revenue, rationalise expenditure, or make tough policy decisions. It is much easier to get the Central Bank to print money the government needs. As a result, Modern Monetary Theory, or printing money, has become very popular among the top management of the Central Bank and they are supported by the Ministry of Finance and Presidential Secretariat, obviously because it is to their advantage.
Given the economic challenges we are facing today because of the pandemic, is there a potential use for MMT in Sri Lanka?
De Mel: Let’s take a look at the recent inspirations for MMT that we have seen globally. I think the popularity of MMT started around 2008 immediately after the global economic recession when Central Banks across the world printed large amounts of money. There was significant quantitative easing across the Federal Reserve, Bank of Japan, and ECB. But that did not result in the increase in inflation as typical monetary theory would have postulated. Further, MMT proponents believe that this link between low interest rates and investment is also broken. It was long believed that when interest rates come down, it triggers investment demand, and then that supports growth in aggregate demand, but this is no longer the case. Despite historically low interest rates, you don’t see investments increasing across the U.S., Europe or Japan.
MMT theorists are convinced that if monetary policy is not generating enough investment then it is incumbent on the fiscal authorities to make use of the low interest rates and run a high budget deficit in less time over an economic downturn. The overall theory implies that if you have an economic downturn, the government can run a high budget deficit and can spend that money without worrying too much about the source of financing. The main reason is the ability possessed by the Central Bank to print money and provide it to the Treasury, without driving up interest rates and without crowding out the rest of the economy or curtailing private investments. The idea is that you keep running this equation until you reach full employment, or till you reach the desired objectives.
MMT theorists are not completely averse to inflation or deny its impact. They do agree that inflation could trigger at some point, and that trigger point will vary from country to country. What they say is that once you reach that level of employment, or level of economic activity, or demand that generates inflation, at that point, you raise taxes and pull that excess cash out of the system, and you pullback aggregate demand to a level which is then not going to generate too much inflation.
In effect, MMT theorists suggest the use of a fiscal tool to achieve an objective, which is ‘inflation control’. Usually, when inflation increases, we raise interest rates to curb inflation. Modern Monetary Theorists turned that on its head and said that monetary policy needs to be subordinated to fiscal policy requirements, and you can still control inflation by raising taxation when required. Similarly, you can achieve your objectives about reducing unemployment, providing social protection, and protecting the environment.
I believe it is crucial to understand that MMT can only be sustained under unique short term circumstances like in the U.S., Japan and some European countries, and it may not be feasible for MMT to applied to all countries in an equal manner since circumstances can vary.
Like most countries, the pandemic has made the economic situation worse in Sri Lanka and we also have huge foreign debt repayments over the next few years. What are your thoughts on deficit spending in the current economic climate? Is some level of deficit spending worth the risk of inflation?
Wijewardena: Throughout post-independence, Sri Lanka’s fiscal deficit has been high except in 1954-5 when we registered a small surplus. We have followed a form of MMT in a limited way over the decades since independence where the Central Bank printed money for government spending and as a result, Sri Lanka’s inflation rate has always been high. For example, consider the old inflation index, the Colombo Consumer Price Index which was based on 1952 prices and abandoned in 2007 for a new index. If the old Colombo Consumer Price Index was 100 in 1952 and you apply prices as at end December 2020, the index value you would get is around 14,000! It means that one rupee in the 1950s is worth less than a cent today. In other words, real income and prosperity of the people of this country have eroded by that same proportion. Then, the limited use of MMT in Sri Lanka post-independence has failed.
When a country’s currency is not a reserve currency, Modern Monetary Theory or Keynesi- an economics does not work. This warning was given to us by none other than John Exter who set up Sri Lanka’s Central Bank
In today’s challenging economic environment exacerbated by Covid-19, the Central Bank can continue to print money for the government, but then the government messed things up by slashing tax rates which eroded government revenue by Rs500 billion in 2020 alone. We expect the revenue erosion to continue in 2021 and as a result, the budget deficit estimate has increased to 8% of GDP up from 6%. Government borrowing has also become a challenge not only for the Central Bank but also for the banking sector because of the fiscal mess created by the government. According to Central Bank data, the government borrowings from the Central Bank and the banking sector amounted to Rs2.2 trillion during the first 11 months of 2020, a record high. Private businesses have only borrowed Rs600 billion during this period. Total public sector borrowings from the banking sector amounted to Rs2.8 trillion during this period and they continue to demand for more. One reason for this is that the Central Bank pushed down interest rates to as much as 4% to stimulate the economy. And this has other implications.
The rupee is now under pressure because import demand is picking up. The government’s import controls are not helping because these controls only cover 20% of the country’s total import bill. The depreciation on the currency is significant even though remittances flows have held despite the pandemic.
Sri Lanka’s monetary easing strategy to counter the Covid-19 economic challenges has backfired. One reason is that the international investor community have taken note that Sri Lanka is applying Modern Monetary Theory, as a result, Sri Lanka’s sovereign bonds are trading at a steep discount in international secondary markets. For instance, a bond maturing in 2030 is trading at $60; at a discount of $40 for each $100. Also, the interest yield has increased to about 15%, which means Sri Lanka cannot now raise money from outside the country unless it is prepared to offer a remarkably high yield to prospective investors. The difficulty we are facing is further evident in a recent issue of development bonds. Development bonds are issued by the Central Bank on behalf of the government to attract locally held foreign currency at commercial banks. The recent development bond issue intended to raise $200 million at 4% which was the usual average rate for previous issues. However, the government could only raise $43 million at 7%! So, interest rates on foreign currency have increased even in the protected domestic market from 4% to 7%.
The U.S. can print money because the dollar is a reserve currency which mostly circulates outside that country and does not cause much inflation. The U.S. has printed about $3 trillion in response to the Covid-19 crisis. Out of this, around 40% is circulated outside the U.S. In other words, its citizens can use stimulus cheques to import goods from other countries and inflation is still less than 1% like it has been over the past few years. Other countries then use these dollars to trade amongst themselves. Sri Lanka’s rupee is not a reserve currency. So, we cannot print rupees to settle foreign loans, we have to convert rupee into dollars. When a country’s currency is not a reserve currency, Modern Monetary Theory or Keynesian economics does not work. This warning was given to us by none other than John Exter in his first press interview after setting up Sri Lanka’s Central Bank. We were warned not to use Keynes’ economic stimulus measures uncritically. However, we have not heeded the warnings and find ourselves in a soup.
If you were a lawmaker, wouldn’t you be keen to extricate people for this short term pain caused by the pandemic while also maintaining some semblance of economic stability which can then be built on for growth? If not for government stimulus, businesses and families that lose livelihoods may take much longer to recover from this crisis, right?
Wijewardena: Definitely! The government has to run a higher deficit to overcome a crisis of this magnitude, where the economy is suffering from massive unemployment, income loss, and a reduction to welfare. However, the government alone cannot rescue the economy, it is the whole economy with all the people like us that have to make a supreme sacrifice. We cannot solely depend on the Central Bank to print money for the government. The government must also raise revenue. Now, what is missing in Sri Lanka is none of the policymakers at the top are telling people about the sacrifices that will have to be made to get the economy back on track for everyone. For instance, we are offered a $500 investment to develop the East Container Terminal at the Port of Colombo. Sri Lanka does not have the $500 million to make that investment that will make the port profitable, generate foreign exchange, business opportunities and jobs. However, there is a public outcry against the Indian investment, much like a family-owned business refusing to grow its business by attracting equity capital because it doesn’t want to dilute ownership. They prefer to borrow instead.
Do you agree that in this climate, the Central Bank cannot be asserting its complete independence, that it has to work closely with the fiscal authority, and potentially help the government out with the large deficit it has now? How do you strike a balance in this unprecedented climate?
De Mel: I think a lot of it comes down to timing. No one disagrees that during an economic downturn, there is an emphasis for stimulus, be it fiscal or monetary. The key is to have an exit strategy at the correct time. What we saw in Sri Lanka in 2020, it made perfect sense in my reading to have some level of defi cit financing by the Central Bank, as you didn’t see that feeding into excess demand, because we saw at that time, private sector credit demand was very low, it was negative between May and August. With credit demand that low, there was space for the government to have a degree of credit from the domestic market without overheating the economy. But you know what? At some point that has to end. When the economy starts to recover, which we all hope will happen in the next few months, at that point the government and the Central Bank will have to find an exit strategy from deficit financing. So far, we are running a high fiscal deficit, but an exit strategy has not been spelt out yet. An exit strategy that will identify how we can shrink the deficit in the medium term will be critical.
Modern monetary theorists imply that governments need not raise taxes because they can print money. However, they also do argue that once an economy recovers, they should start raising taxes
The government has said that it intends to maintain the current tax policy for the next five years so its not clear how it plans to reduce the deficit. The starting point is important. Most countries introduce stimulus measures with the deficit already around 2-3% of GDP, so pushing it up to 6-7% without causing too much stress is not difficult. In Sri Lanka’s case, however, we are talking about a deficit that was already near double digit levels. Maintaining the deficit at the current already high levels for an extended period is different from increasing the deficit from 3% of GDP to 7% for a short period. It’s the same with Modern Monetary Theory. Countries that started with MMT measures already had real interest rates that were close to zero or negative.
In Sri Lanka, we still have positive real interest rates and there is still space for the relationship between investments and interest rates to work. We don’t have evidence to suggest that the relationship is broken. Hence, the applicability of MMT to Sri Lanka’s particular circumstances differ from a country like the U.S. and that is where the crux of the matter is: we do not know what that exit strategy is and the conditions in which an MMT strategy can work in Sri Lanka or not
How does one go about crafting an exit strategy nowadays, especially after the government has said it will not change the current tax regime?
Wijewardena: Modern monetary theorists imply that governments need not raise taxes because they can print money. However, they also do argue that once an economy recovers, and GDP growth has reached a certain level, governments should start raising taxes. This way, the stimulus given with printed money can be quickly neutralised, this is the exit strategy Deshal was telling us about. But for this to happen GDP and tax elasticity should be consistent or high, which is not the case in Sri Lanka. When GDP grows taxation falls. In the 1980s tax revenue was about 80% of GDP and today its around 2%. So tax elasticity of income is negative in Sri Lanka, as a result, we persist with higher deficits for an extended period which is fundamentally opposed by modern monetary theorists. What we need is an economy-wide scaling back of consumption.
De Mel: The fiscal deficit is the key here, but it does not mean that we go from where we are today to a 2% of GDP deficit overnight because this will kill any economic recovery that we may have. What we do need is a plan to scale back the deficit from 9% of GDP to about 5% in five years, and then bring it down further beyond that. There are a number of tax measures that can be introduced without hurting growth. For instance, PAYE and withholding tax thresholds can be eased so that you broaden the tax base as well. Then there are non-tax measures such as auctioning broadband spectrum which can generate significant revenue to the treasury. There are a number of measures that can be looked at but fundamentally, what we have to do is to address the budget deficit in the medium term. Now, MMT says that you need not worry about the budget, that you can have a budget deficit as high as you want because the Central Bank can print money and finance that without a problem. However, Mr Wijewardena and I argue that it just doesn’t work in a country like Sri Lanka, where 50% of our debt is denominated in foreign currencies, Sri Lanka cannot use the monetization path purely in terms of addressing our debt problem.
Money printing has caused the Central Bank’s treasuries holdings to swell. Is this something investors or those in the private sector should keep an eye on? Is it a critical indicator of economic health in the future as the Central Bank’s balance sheet has exponentially grown?
Wijewardena: The Central Bank balance sheet is out of shape, but with the additional investment from the money printing exercise, it will end up making a huge amount of profits at the end of the year. And the government benefits from this too because it can transfer profits to the treasury. In 2019, the Central Bank reported a Rs25 billion profit of which Rs24 billion was transferred to the central treasury. The chances are the Central Bank will make huge profits in 2020 and the government will get it all. So in the other words, the government is printing money, spending it and the yield the Central Bank earns in the process is also appropriated to the state. It is a very lucrative business for the government whereas in the Central Bank’s case, the result would be that the Central Bank will need proper capital adequacy and without which it could have become bankrupt like any other commercial bank, as it has happened to many Central Banks in the world.
We are in a situation where we are not in a position to balance this properly. As Deshal said, the exit level is a very important thing and I agree with him that given the current scenario, we have a massive amount of unemployment and people are in hard times; so there is a need for stimulus. But that stimulus has to come from our real efforts, not from monetary policy. That is what I believe. Many people think that money can do many things, but money is simply a notion in our heads, it has no real existence. It derives its real existence and value from the basket of goods and services it can buy. If that basket of goods is shrinking, inflation sets in and poor people are the ones who end up making all the sacrifices. Inflation is a tax on poor people. People with affluence and wealth can easily adjust, move assets from fixed income instruments to real estate and even equities. Poor people not only see their savings erode, but the quantity of goods and service they can buy for the same amount of income is also shrinking. So, as a result, they face the brunt of inflation.
Inflation tax is a way for a government to tax low income citizens so it can continue to run the government, and this is what continuously happens in Sri Lanka since independence. This is why plantation workers are clamouring for a Rs1,000 daily wage, and why we have constant trade union agitations in this country. As I explained earlier, in 1952 inflation indexed at 100 is today around 14,000, so real incomes have fallen in this country, and so has real consumption. Sri Lanka adopts Modern Monetary Theory, prints money and when inflation hits the economy, poor people are compelled without them knowing it to perform a form of Rajakari Kramaya, or compulsory royal service, to pay an involuntary tax so that the government can sustain itself.
While inflation is a terrible thing, debt is a financial asset, and the ultimate real value of that debt is also inflated away. Can you explain what happens here and the likely implication for Sri Lanka? Wijewardena: Presently, we are having a terrible macro-economic imbalance in Sri Lanka, our growth rate is falling and in 2020, it is negative even though the government is hopeful that it will become positive in 2021. Many analysts feel that low or negative economic growth will continue till about 2024. The situation with public debt is worrying because the government is not earning enough revenue to even cover the interest payments let alone repay the capital.
Similarly, the external sector imbalance is growing and even though imports are restricted, and the trade deficit is marginally down, and with poor foreign direct investment flows, Sri Lanka is facing a chronic shortage of foreign currency to repay maturing debt over the next few years. Under the current conditions, Sri Lanka cannot approach international markets to roll over debt or raise fresh capital. The Central Bank has not published the end-December 2020 foreign reserve position in its weekly indicators which is a must, in terms of the agreement with the International Monetary Fund under the Special Data Distribution Standard. It has to publish the latest data on the reserve position, but that has not happened. Only end-November 2020’s reserve position is given as $5.5 billion, and there is a gold stock worth $340-400 million which cannot be used unless it is sold in the market. The government’s foreign debt repayments over the next 12 months amount to about $5.7 billion, on top of that there are short term liabilities of about $1.4 billion which takes the total to over $7 billion. We are negotiating swaps from India and China for about $2-2.5 billion which is peanuts. Also, people expect the government to invest $500 million to develop the Eastern Terminal at the Colombo Port, which we don’t have. Sri Lanka’s external position is rightly read by the rating agencies and market analysts.
If you look at Sri Lanka’s his- tory over the last 10 years, the manifestation of excess de- mand, or demand moving fast- er than supply, typically has not been in the form of inflation at first but on the balance of payments
A recent country update by Citibank had gone even further and suggested that if all the short term liabilities are removed, Sri Lanka’s current reserves amount to about $2.5 billion, which is less than a single month’s imports. This is why although some people say that we cannot cut consumption without affecting the economy’s growth, but naturally, we’ll be forced to do just that when we don’t have money to buy foreign goods.
But if we reduce consumption at this point, when the economy is so fragile, will we scuttle the potential for any recovery?
Wijewardena: What we mean by consumption demand is not only local consumption but foreign consumption of our exports as well. What we are doing is cutting local consumption and producing goods and services for export, so there is no decline in the consumption of goods and services produced in Sri Lanka. In today’s context, our goods and services exports have become stagnant over the last 10 years so we will have to now curtail our local consumption and make available those goods and services for the use by other people living outside the country and earn valuable foreign exchange.
This was the exact strategy adopted by Japan after the Second World War, where local consumption was 50% of GDP and the rest was exports. They then invested in research and development and built capacities of local businesses. This is the same strategy the government of Sri Lanka should follow instead of promoting domestic consumption. We need to cut domestic consumption and create savings which can be used for exports. To do this, we need a comprehensive policy to develop and promote exports and this is what is lacking.
But is this something we can do fairly quickly, because the pain is immediate?
Wijewardena: No, we cannot do it fast. Vietnam came up with a new economic policy program in 2019, which would have enabled Vietnam to convert its economy to the fourth industrial revolution in year 2030, which is a 10-year roadmap. As we have already lost many years by not planning ahead, and if Sri Lanka started today probably with new technology and new direct investment, then Sri Lanka just might be able to reach that goal by 2030.
De Mel: The imbalances start to occur when you have excess demand or consumption, which is when your demand is growing at a faster rate than your supply.
When you are in a downturn, it only begins to manifest itself when the economy is recovering. If you look at Sri Lanka’s history over the last 10 years, the manifestation of excess demand, or demand moving faster than supply, typically has not been in the form of inflation at first but on the balance of payments. If you look back at 2011-2012 and 2015-2016, both periods are preceded by fairly low interest rates, again that 6-7% range, and immediately followed by balance of payments pressure: basically, a sharp increase in the current account deficit and a balance of payments crisis immediately after that. So that is how excess demand manifests in Sri Lanka.
In 2020, we were not there for certain. We did not have a sense of excess demand and that is why we were able to run this model which has elements of modern monetary theory without having a significant impact on the currency and without having a significant impact on inflation as well. Now, the challenges are going to come once we start to see the economy recovering. The BOP issue is really manifesting itself because most of Sri Lanka’s imports are inputs in the production process. Only 20% of Sri Lanka’s imports are for consumption, 80% of Sri Lanka’s imports are either intermediate goods or capital goods. Whenever we have investments, it leads to economic activity and demand for inputs starts to increase. So as the economy recovers, you will see the demand for inputs increasing which will exert more pressure on the BOP. Thus, before inflation starts to bite, it is the BOP issue that’s going to start to manifest.
Since the second week of December 2020 to early January, the rupee started coming under pressure which is the initial sign of BOP problems. This is when interventions are required to try to address the issue and avert a BOP crisis. Modern monetary theorists will suggest different approaches of doing this. Traditional economists may suggest raising interest rates to put the breaks on aggregate demand. Modular theorists would suggest directed lending where banks can be directed to curtail their lending to imports and focus lending to other sectors such as agriculture which do not require imported inputs. Consumption can be managed in different ways. But what we can see is that these kinds of interventions are a false measure. There is one option that is tough to execute and I am not going to say if it will work or not, but it can lead to a salvageable situation. If Sri Lanka is going to persist with modern monetary theory, and the government is stubborn about spending in order to stimulate the economy, then it may make better sense to spend on areas that will increase the economy’s supply-side capacity, such that the supply capacity of the economy grows at a faster rate than the demand side of the economy, then again, you can prevent overheating. But that is a very tough one to achieve, because there is a huge time lag between what you spend and what you invest translating into supply capacity. Theoretically, that is something that the government can aspire to do. It’s a spending measure that can have a chance of coming close towards working I’m not going to say that it works or not, but that is the kind of salvageable measure that you could run
Unfortunately, the current management of the Central Bank is under the illusion that economic stability means to promote economic growth, and they can’t be more wrong
Some analysts point out that Sri Lanka’s economy has a lot of excess capacity—for instance they argue that there are lots of idle factories and you can also run double-shifts in those already operational. Is that true? What is your take on this?
De Mel: There’s certainly unemployment in the economy and that has manifested particularly during the pandemic, but I think the problem is that even when you try to deal with supply capacity shortfalls, it can lead to problems. This is because investing in manufacturing or supply capacity improvements lead to imports. About 80% of Sri Lanka’s imports are intermediary goods so this is why supply-side enhancements can be tricky. Most countries can move from a low supply base to full employment without triggering inflation or balance of payments pressures, but not Sri Lanka. The nexus between economic activity and the BOP is very tight. So, I think that it is really sad that that kind of balancing act becomes quite tough for us.
Wijewardena: We don’t have to wait anymore, Sri Lanka is already in a Balance of Payments crisis. We cannot repay are debts so either we default or negotiate rescheduling. The rupee is also under pressure and the Central Bank is doing everything it can to keep it from depreciating. They are arm-twisting forex dealers to try and keep the exchange rate steady but what happens is the market always fights back as we have seen in 1998, 2001, 2009 and 2013. Arm-twisting, or moral suasion works for a very small period, in any case a massive decrease in the currency’s value is due in any case. The value of the rupee will definitely fall and as a result, there must be an adjustment made sooner as it is better for Sri Lanka, rather later.
What do you think about inflation, where will we end 2021?
Wijewardena: Inflation will likely reach double-digits by the middle of the year and so probably double from where it is now. Right now, the Central Bank seems quite happy with itself. Like an ostrich burying its head in the sand not realising everyone else sees it. So that is what it’s like I suppose for the Central Bank. They control prices and also calculate the inflation rate by taking those controlled prices into account, and are very happy and satisfied that inflation has not picked up beyond 6%! This is exactly why a former Governor of the Central Bank Mr A. S. Jayawardena introduced the objectives of economic and price stability in the core priorities of the Central Bank. He intended for the Central Bank to achieve something more than mere technical price stability by just controlling prices and intervening in markets. He wanted the Central Bank to achieve economic stability and that means having a balanced view of the macroeconomic picture be it the budget, balance of payments and domestic credit. You may have excess demand on any side, but the economy must be balanced, it should be stable. Unfortunately, the current management of the Central Bank is under the illusion that economic stability means to promote economic growth, and they can’t be more wrong. This was something Mr A. S. Jayawardena warned us about.
De Mel: It will be useful to take a broad view of what inflation. When we typically talk about inflation, we talk about the Colombo Consumer Price Index and inflation in goods and services. When I think again about the trigger point to exit from MMT measures, I said it was BOP pressure, but there’s an even bigger trigger, asset price inflation. When you see this level of liquidity that’s been pumped into the market, the first place where a lot of that cash is going into is assets that are seen often as hedges against inflation such as land, equity markets or gold. And this is again, not just phenomenon. We are seeing this in many countries now and this has been happening due to accommodative monetary policy worldwide as countries tackle the economic fallout from the pandemic. Even Bitcoin has appreciated to high prices. I believe the Central Bank will still be sensitive to inflation going into double digit levels but they will also be a lot more tolerant under the present government. I think the language from the policy statements from the Central Bank suggests a tolerance for inflation to reach above 4-6%, but they would want to keep it below 10%. Mr. Wijewardena suggests inflation will reach double digits by June 2011, but I don’t know if will get there that fast. I think the Central Bank will start to jitter, if it is showing signs of going into double digit levels, but it will be tolerant of higher inflation than we have seen in the recent past.
Capital market analysts have tremendous optimism that the government may be able to navigate away from this crisis. Sri Lanka’s friends China and India may step up with foreign debt repayment needs. How practical is it for those in the capital market to be so optimistic?
Wijewardena: Beggars are not choosers. We are not at liberty to choose from where we borrow and where we get assistance from, and the two countries that come to my mind are India China. They have interests in Sri Lanka and they might provide the means to overcome our problems. Sri Lanka will have to play this game very carefully and smartly without offending either country. But, you know, people are correct when they assume that both these friendly countries will come to Sri Lanka’s aid. They have to. India does not want economic chaos at its doorstep. Likewise, China has strategic interests in the region so both countries will be keen to invest here. Likewise, we will be able to curtail domestic consumption and we can increase our exports to the rest of the world with Chinese and Indian support. Thailand developed special economic zones ten years ago and they were managed by Chinese management firms and global brands from around the word like Samsung from South Korea and Panasonic from Japan set up production facilities at these zones. Thailand’s high-tech exports grew from virtually nothing
to about 40% of total exports in a decade, and during this period Sri Lanka has only managed 1%. This is the model we can follow starting with Hambantota. We can be successful by engaging both China and India, but we have to play the game very carefully and get the investments this country needs.
De Mel: It’s not a one-off game. We have about $20 billion in debt maturing over the next five years. Right now, reserves amount to $5.5 billion and we don’t have access to international capital markets to rollover debt, so Sri Lanka needs something to fill that gap. Negotiating swaps may help to ease some of the pressure but I think the bigger part of the government’s strategy is in terms of trying to attract foreign direct investment. Talking about addressing the external debt component, the expectation is that we can use FDI to replace the capital inflows that we got from the sovereign bonds and syndicated loans in the past. This is an ambitious objective, particularly because FDI takes time to materialize, there’s quite a bit of a lag normally between the start of a project through to the conclusion. The most feasible way in which the government can raise external non-debt financing quickly is by the divestment of existing state-owned assets, be it land or shares of companies. That is the fastest way to achieve our foreign exchange requirements, but of course, it is politically quite challenging. We all know the government has the political capital but to pull it off, it must play all the right cards.
The whole idea of trying to shift from state-owned foreign debt to local debt is again not a sort of new strategy, that has been in play for a while, and published in the 2018 medium-term debt joint strategy of the Central Bank and Treasury. However, instead of trying to do this overnight, it should be done in phases so that we don’t run into any rollover risks, which is why attracting FDI is so critical.