ECONOMYNEXT – Sri Lanka’s recurring monetary instability is due to lack of industrialization and not money printing or budget deficits, Howard Nicholas, an economist said, though the hot favourite now is lack of tourism revenues.
Others have blamed Sri Lanka’s monetary troubles on trade deficits (the usual suspect), oil, vehicles (another usual suspect), low productivity, exiting rupee bond holders (after 2015 in particular).
Throughout the 1990s controlling budget deficits were given as a ‘panacea’ for all economic ills but the country continued to have current accounts deficits and currency troubles, Nicholas who is from International Institute of Social Studies (ISS), Erasmus University Rotterdam said.
Budget deficits was blamed for crowding out private investment by the International Monetary Fund and others he said.
“The reason was the lack of industrialization,” he told a business forum in Colombo.
Industrialization had happened in the late 1980s under President Premadasa, he said.
In Sri Lanka there were lot of opposition to money printing.
But Nicholas said the idea was no longer ‘fashionable’.
However he said unlike Modern Monetary Theory advocates he did not believe that money printing and deficit spending could be continued all the time.
The industrialization was the answer to end balance of payments troubles he said. He said industrialized countries such as in East Asia for example have current account surpluses.
“Vietnam went aggressively for industrialization in 2010 and they never had a balance of payment problems,” he claimed.
As the US housing bubble collapsed in 2008/9 Vietnam engaged in a stimulus attempt cutting rates and triggered a currency crisis.
The dong collapsed from around 15,000 to 21,000 dong.
By 2012 overnight rates were topping 14 percent as the State Bank of Vietnam desperately defended the collapsing dong amid an unsustainable boom.
The country was left with massive bad loans after that.
The SBV has since been using the exchange rate as an inflation anchor for low inflation and stability and trying to dispel the US led Mercantilist myth that its currency is ‘undervalued’.
Vietnam has so far resisted IMF and US pressure to move into ‘flexible inflation targeting’ a highly discretionary non-regime.
Vietnam’s stability and growth, both in domestic non-tradabel and export activities started to happen after SBV reforms in the late 1980s when its bank credit operations were separated into commercial banks to stop central bank re-financing, analyst familiar with Vietnam say.
Soon after the economy re-opened in 1986 the currency collapsed as credit expanded, triggering boat people and an uprising in the highlands.
The first SBV reforms were almost similar to Peoples Bank of China reforms under Deng Xiaoping’s in 1978. However partly due to state enterprises finance the Renminbi continued to have problems until the late 1980s was fixed in 1993 as an external anchor.
Nicholas said in Sri Lanka now people are complaining of money printing, but Japan was printing money but did not have inflation.
However Japan also had high inflation when it was printing money with a pegged exchange rate, until the currency was fixed at 360 by US banker Joseph Dodge under Amerian occupation, as inflation hit triple digits and food shortages were worse than the war.
Korea, the poster child for state backed industrialization also had severe currency crises, inflation and high interest rates to defend the currency, subsidized credit and government guarantees for foreign loans until the Bank of Korea was successfully reformed in the early 1980s.
Korea’s First Republic collapsed along with currency under a US-built central bank designed by Arthur Bloomfield, a Fed official like John Exter, who built Sri Lanka’s Latin America style central bank.
However Bank of Korea (in its second re-incarnation) was reformed around a dozen times and periods of exchange rate stability of at least two Fed cycles at a time which allowed for stability.
Korea won appreciated for the first time in the 1987. Countries like Singapore and Hong Kong and to a great extent Malaysia (until 2006) had very low interest rates due to orthodox currency boards or currency-board-like systems.
Like Ceylon before the US-built central bank, their currencies were stable long before they became industrialized.
One of the most industrialized countries in the world Germany also had currency troubles and defaulted until the Deutsche Bundesbank was built by Ordoliberals and Joseph Dodge.
Central Banks generally get a free pass for policy errors with monetary instability in the form of inflation, credit bubbles (and balance of payments troubles if is pegged), being blamed on cost-push, commodity prices, imports, overvalued currencies (REER), trade deficits and current account deficits.
The latest free pass to reserve currency central banks is ‘transient inflation’ and ‘supply chain’ problems.
Over the past year Sri Lanka has blamed currency troubles on the lack of tourism revenues.
Though budget deficits economists have pointed out that budget deficits which transfer private spending power to the government cannot create any additional demand unless accommodated by the central bank.(Colombo/Dec06/2021)