ECONOMYNEXT – Sri Lanka has outperformed a debt to GDP ratio target in an International Monetary Fund as the central bank missed the high inflation target it has set for itself, unexpectedly providing monetary stability to the country.
Sri Lanka’s central bank has got itself a 5 percent inflation target, the same level under which it printed money and triggered four currency crises without a war and eventually the country ended up in external default in a peacetime default, Latin America style.
Sri Lanka’s central government debt to GDP ratio was estimated ats 98.7 percent by end 2024, Harsha de Silva, Chairman of the Parliament’s Committee on Public Finance said, tabling a report.
Positive Path
“Sri Lanka’s debt trajectory remains on a positive path, benefitting from improved economic performance, stable exchange rates, and lower than expected inflation as per the IMF projections,” de Silva told parliament.
An IMF debt sustainability analysis had projected debt to GDP ratio at 108.8 percent, he said.
Sri Lanka’s nominal GDP for 2024 has been projected around 30 trillion rupees according to the latest budget documents, down from an initial projection.
The last quarter official GDP estimate is not out yet. Some SOE loans, including at Sri Lankan Airlines, which are under government guarantee are yet to be fully absorbed into government debt.
In 2024, Sri Lanka also restructured its sovereign debt. The budget showed a negative 3 trillion rupees in foreign financing.
Now that the debt restructuring is complete, Sri Lanka’s DSA is likely to have been revised in the new program to be approved on February 2028.
Sri Lanka’s central bank missed its 5 percent inflation target in 2024, while the exchange rate was maintained around 300 to the US dollar going against the IMF’s usual practice of depreciating currencies (competitive exchange rates) which leads to social unrest, destruction of capital and eventual high nominal interest rates.
The central bank also appreciated the currency from 360 to 300, after restoring lost confidence in the rupee by engineering a private credit collapse, bringing traded goods prices down and offsetting service price rises that continued after the 2022 currency collapse.
However the ‘debt deflation’ has now ended and private credit is positive.
Maintaining an exchange rate peg is childishly simple, economic analysts say, as long as the parliament is willing to exercise its responsibility to the public, and tame the liquidity injection powers of a money monopoly and its insistence on creating high inflation against the public interest.
Sri Lanka and many other countries that jettisoned external anchors suddenly started to experience higher inflation than developed nations after 1978 in particular with the Second Amendment to the IMF Articles.
Wholesale external defaults started at the same time as the US tightened policy around 1980 and Latin America in particular, which had commercial debt, failed to maintain monetary stability.
Undemocratic
Economic philosophers especially in Germany, where classical economics survived after World War II, have pointed out that money printing, currency depreciation and inflation advocated by Anglohone academics are inimical to democracy and parliamentary control of budgets.
Classical economists have maintained that sound money is an essential requirement from individual freedom and liberty.
“Inflation is essentially antidemocratic. Democratic control is budgetary control,” classical economist Ludwin von Mises wrote.
“The government has but one source of revenue— taxes. No taxation is legal without parliamentary consent.
But if the government has other sources of income it can free itself from this control.
“If war becomes unavoidable, a genuinely democratic government is forced to tell the country the truth. It must say: “We are compelled to fight for our independence. You citizens must carry the burden. You must pay higher taxes and therefore restrict your consumption.”
“But if the ruling party does not want to imperil its popularity by heavy taxation, it takes recourse to inflation.
“The days are gone in which most persons in authority considered stability of foreign exchange rates to be an advantage. Devaluation of a country’s currency has now become a regular means of restricting imports and expropriating foreign capital.”
Mises wrote this as Anglophone academics got increasingly enamored with inflation and Keynsianism, in the run up to and after World War II.
A slump is inevitable after Inflationary Rate cuts
Mise warned that any inflationary growth will be followed by a stabilization crisis usually under a different government.
“They have all sold their souls to the devil of easy money,” he said. “The inevitable slump will occur later and burden their successors. It is the typical policy of après nous le déluge. Lord Keynes, the champion of this policy, says: “In the long run we are all dead.”
“But unfortunately nearly all of us outlive the short run. We are destined to spend decades paying for the easy money orgy of a few years.”
Under the cover of a ‘mid-single digit inflation’ the central bank triggered currency crises in 2012, 2015, 2018 and 2020 by printing money to cut rates, including halfway into IMF programs (2012 and 2018).
Overt mid-corridor rate targeting (de facto single policy rate) with an abundant reserve regime (excess liquidity) started in 2015.
In 2018 the central bank managed to trigger a currency crisis as then Finance Minister Mangala Samaraweera hiked taxes, cut the deficit and also market priced oil as the IMF program did not have a ceiling on domestic assets.
The current IMF program has a ceiling on domestic assets, under which the central bank operated broadly deflationary policy to build reserves from 2022 until the third quarter of 2024.
As a result, it missed a 5 percent inflation target it had persuaded political authorities to give.
Helicopter Drop
In the last quarter of 2024, the central bank made a ‘helicopter drop’ of money injecting 100 billion in rupee reserves into the banking system to inflate the monetary base.
It then lost the ability to build reserves foreign and ran a BOP deficit in December as imports surged to crisis level highs.
The demand for a high inflation target seemed to be driven by a belief that inflation was needed for growth rather, its past failures to provide lower inflation (econometrics) and also by benchmarking against third world countries with similarly bad operational frameworks
Related Sri Lanka central bank reveals motives for demanding 5-pct inflation target
Most East Asian nations that succeeded in becoming export powerhouses including Taiwan, Thailand, Singapore and Malaysia rejected inflationism and deprecation in toto.
Taiwan because of Sho-Chieh Tsiang, an award-winning LSE student of Mises’s colleague F A Hayek, Singapore because of Goh Keng Swee, also an LSE graduate and Japan because of Joseph Dodge.
Dodge had worked in Germany creating the Deutsche Mark and had helped set up the Bank deutscher Länder (pre-cursor of the Bundesbank).
GCC countries to which Sri Lankan expatriate workers are driven to by monetary instability also rejected currency depreciation and followed either neutral policy or mildly deflationary policy. (Colombo/Feb25/2025)
