Macroeconomics and Policy Efficiency

A Fiscal Council for Sri Lanka: Pathway to Regaining Fiscal Credibility

Sri Lanka was once considered a development success story. But within the last few decades, this legacy was lost to governance failures and economic mismanagement. In recent years, the country has been characterised by a glaring lack of fiscal discipline reflected in the inability to raise sufficient revenue even to cover current spending. In this context, institutions have a major role to play in ensuring that governments do not fail. Effective institutions can (1) assure the provision of quality services which is essential for eradicating poverty and promote shared prosperity; (2) guarantee high-quality public spending and minimise corruption; and (3) ensure that all citizens benefit from economic growth and that development is not lop-sided. With this understanding, this blog discusses how a Fiscal Council (FC) can help Sri Lanka regain fiscal credibility and improve its overall economic performance.

Stagflation in Sri Lanka? Risks and Policy Responses

The emergence of a low-growth international environment together with a significant rise in inflation has raised concerns of stagflation; a period of low growth combined with high inflation. A global stagflationary environment can worsen Sri Lanka’s current economic crisis restricting growth and increasing inflation. Increased policy rates to combat inflation will result in lower investments. These factors, combined with political instability, lower-than-expected remittances, and lower productivity due to acute shortages of essential items will further constrict the Sri Lankan economy, pushing it into stagflation. Due to a global economic downturn, rising commodity prices and high rates of borrowing, Sri Lanka can expect a challenging external sector environment next year. Policymakers will need to understand these global challenges and make pragmatic economic decisions to minimise further damage to the economy.

Sri Lanka’s Runaway Inflation and the Limits of Monetary Policy

Having kept monetary policy too loose for too long, Sri Lanka started its tightening cycle in August 2021. It signalled firm intentions to regain the Central Bank of Sri Lanka’s (CBSL) focus on price stability by engineering a reduction in demand through high interest rates and withdrawing liquidity from the economy. Effectively, in the current dire growth outlook for Sri Lanka, the policy intention means forcing a recession to tame inflation. In choosing between the options of an aggressive hike that will lead to a recession or tolerating a prolonged inflationary spiral bordering on hyperinflation, the former is preferable. Once inflation takes hold, the damage can be corrosive, especially its deeply regressive impacts on lower income households. But a contractionary strategy to suppress demand will not achieve the desired outcomes if (a) inflation expectations are not well anchored and people expect rapid price increases to continue, and (b) supply side factors remain unaddressed.

Currency Board: A Solution to Sri Lanka’s Economic Crisis?

On 08 March, Sri Lanka devalued the rupee against the US dollar, entering into a floating exchange rate regime. The Central Bank of Sri Lanka had to abandon the pegged exchange rate as defending the rupee with dwindling reserves was impossible. The inter-bank exchange rate shot up once the banks were assured that the exchange rate was floated. The initial shoot-up was followed by further rallying of the US dollar reaching close to Rs. 300 per USD. With the gradually weakening rupee, inflation is also ascending to worrisome levels calling for radical changes, including adopting a currency board. This article discusses the effectiveness and suitability of a currency board for Sri Lanka in the current macroeconomic context. It argues that a currency board will be helpful to stabilise inflation in the short run but in the long run, Sri Lanka will be better off with a more flexible exchange rate regime.

COVID-19, Fiscal Policy and Public Debt in Emerging Economies

One year into the pandemic, Sri Lanka’s already tight fiscal space has become further constricted, leaving some tough decisions to be made in the pandemic recovery period. A third wave of COVID-19 that the country is currently experiencing will further delay such recovery efforts. Although some fiscal tools have been included in Sri Lanka’s COVID-19 recovery plan, there is consensus that the size and scale of the country’s fiscal stimulus package have been inadequate against the scale of the crisis. Conversely, wealthier countries have been rolling out some of the historically largest fiscal stimulus packages. This blog discusses the global tilt towards fiscal policy reliance in the aftermath of the pandemic and deliberates on how far the developing world can adopt a similar strategy.

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