ECONOMYNEXT – Sri Lanka’s gross domestic product is projected to grow 4.5 percent in 2025, the central bank said in a monetary policy report, as the agency missed its 5 percent inflation target but promised ‘reflation’ soon.
The latest forecast for GDP for the 2nd quarter of 2025 is expected to be ‘robust, continuing the positive momentum observed in 2024 and the first quarter of 2025, the agency said in a Monetary Policy Report for August.
“As per the currently available information, economic growth for 2025 is projected to be around 4.5 percent,” the central bank said.
“Looking ahead, economic growth is expected to continue its modest expansionary momentum over the medium term.
“However, external demand conditions and evolving global geoeconomic landscape increase the level of uncertainty associated with growth prospects over the near to medium term.”
The rate is higher than the 3.5 percent projected by the International Monetary Fund. The IMF projected deliberately conservative growth numbers after the default, which also helps get a steeper haircut from the creditor.
Deflation
The central bank missed its 5 percent inflation target through which critics say it triggered currency crises without war in 2012, 2015, 2018 and 2019-22 through the relentless pursuit of 5 percent inflation without war.
Deflation or no inflation, lifts a load off the shoulders of hardworking families, allowing nominal wage growth, (backed by capitalist productivity growth) however small to improve living standards and buy more goods and services, which requires more products and services to be delivered.
But modern macroeconomists believe that inflation (price pressure) is essential for growth, or employment (employment inflation trade-off) but in the process trigger crises and social unrest without war in the relentless pursuit of increases in cost of living.
When then Prime Minister Margaret Thatcher ended Great Inflation in the UK with deflationary policy in the early 1980s, 364 Cambridge economists protested, in a letter which they said was signed by 76 ‘professors or past professors’, the ‘President, 9 Vice-Presidents, and the Secretary General of the Royal Economic Society’ among others.
“[T]here is no basis in economic theory or supporting evidence for the Government’s belief that by deflating demand they will bring inflation permanently under control and thereby induce an automatic recovery in output and employment,” they claimed.
Sri Lanka’s unemployment fell to 3.8 percent in the first quarter of 2025, with no stimulus, and only the stability provided to hardworking families and also businesses with deflationary policy and a stable exchange rate.
Reflation
Sri Lanka recovers faster from a crisis induced by ‘macroeconomic policy’ or ‘reflation’ because part of the workforce flee to countries without monetary policy (especially GCC nations) or those with lower inflation targets around 2 percent and send remittances home without settling there.
Prime Minister Thatcher had to fight members of her own party who opposed deflationary policy like in Sri Lanka.
“Mrs Thatcher certainly knows as well as anybody that it would be possible quickly to reduce unemployment for a time by increasing inflation (“reflation”),” classical economist F A Hayek wrote in 1982 after an attack on her policies by a member of her own party.
“But for this, as we ought to have learnt by now, we would have to pay by even more severe unemployment later on.
“It is Mrs Thatcher’s great merit that she has broken with the Keynesian immorality of “in the long run we are all dead” and to have concentrated on the long run future of the country irrespective of possible effects on the electors.
“Mrs Thatcher’s courage makes her put the long run future of the country first.”
Hayek wrote the letter from then Federal Republic of Germany, which had pursued deflationary policy after World War II creating conditions for the ‘German Economic Miracle’ also appreciating its currency at least one the 1960s as the US embarked on ‘full employment’ policies.
Sri Lanka’s central bank is also promising ‘reflation’ next year, after itself creating the necessary conditions for an almost ‘miraculous’ economic recovery without ‘stimulus’.
“Deflation is expected to end in Q3-2025 and a gradual acceleration of inflation is expected thereafter to reach 5 percent in mid 2026,” the monetary policy report said.
“In the medium term, inflation is projected to stabilise around the target of 5 percent albeit with possible transitory peaks along the inflation path.”
‘Reflation’ economics reared its head in the US from around 2000, to end the supposed ‘deflation’ of the 1990s, spearheaded by Princeton economist Ben Bernanke (who was working under Greenspan at the time), leading to the Housing Bubble and the abundant reserve regime (single policy rate) that came in its wake.
Prophetic
“The conclusion that deflation is always reversible under a fiat money system follows from basic
economic reasoning,” Bernanke said in a speech in 2002 which proved chillingly prophetic.
“A little parable may prove useful: Today an ounce of gold sells for $300, more or less. Now suppose that a modern alchemist solves his subject’s oldest problem by finding a way to produce unlimited amounts of new gold at essentially no cost.
“What has this got to do with monetary policy? Like gold, U.S. dollars have value only to the extent that they are strictly limited in supply.
“But the U.S. government has a technology, called a printing press (or, today, its electronic equivalent), that allows it to produce as many U.S. dollars as it wishes at essentially no cost.
“By increasing the number of U.S. dollars in circulation, or even by credibly threatening to do so, the U.S. government can also reduce the value of a dollar in terms of goods and services, which is equivalent to raising the prices in dollars of those goods and services.
“We conclude that, under a paper-money system, a determined government can always generate higher spending and hence positive inflation.”
Gold is now 3000 dollars an ounce.
Unlike countries with floating exchange regimes (where currency crises are not possible) where inflationary policy mainly trigger asset price bubbles, in countries with reserve-collecting central bank mis-targeted rates manifest themselves in the balance of payments fairly quickly, analysts have said. (Colombo/Aug15/2025)
