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CB refutes claims that higher rates put strain on government funding

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Says higher rates compel govt. to cut borrowings, raise revenues and thereby aim a primary surplus

Pushing back on the claims that higher rates cause the government to foot an enormously high interest bill on the borrowings it makes, the Central Bank said the data from the last two years proved otherwise even when the interest rates remained at historical low levels. Therefore, the rates wouldn’t necessarily determine the amount of borrowings and their related costs but a sensible fiscal policy does.

Responding to a question on how the Central Bank would defend its higher interest rate policy in view of the rising debt servicing burden of the government, Central Bank Governor, Dr. Nandalal Weerasinghe said such a policy compels the government to fix its budget through revenue and expenditure management, which is entirely within its control and thereby report a primary
account surplus.

Primary account balance in the budget is the difference between State revenues and expenditures barring the interest cost.

The only time Sri Lanka achieved a surplus in the primary account in recent history was in 2017 and in 2018 when the country was under its 16th International Monetary Fund (IMF) programme.
Even then, the two surpluses came in at slightly above zero at 0.02 percent and 0.6 percent of the Gross Domestic Product (GDP). The government this time has committed for a 2.3 percent primary account surplus in 2025 under its 17th programme with the IMF, which appears to be a tall order to achieve, according to both international and local economists.

While the progress reversed in 2019 due to the Easter Sunday deadly attacks, heightened political uncertainty and the Presidential polls held in that year resulting in a 3.6 percent primary deficit, the pandemic induced lockdowns and the tax concessions delivered in late 2019 caused the deficit to expand to 4.6 percent and 6.0 percent in 2020 and 2021.

Dr. Weerasinghe said just like any other entity, the government too is required to find its optimal funding mix and make necessary reforms to rely less on borrowings to meet their expenditure needs, especially when rates remain elevated. “This is why even under the current fiscal consolidation programme, the government will have to report a primary account surplus of the fiscal account that will help to bring the debt to a sustainable level,” he said.
“Like any other entity, if the government finds that interest rates are too high, they will have to bring down borrowings. To bring down borrowings they will have to increase revenues. As a result their interest expenditure is going to be lower going forward”, elaborated the governor, explaining how the government could escape the implications of higher rates.

He recounted how the two years of blow-out budget deficits in 2020 and 2021 were funded through printed money citing historically low interest rates, which neither helped the government to keep its debt servicing expenditure under control nor retain its debt at a sustainable level, and instead fired the worst inflation Sri Lanka has ever experienced while plunging the country into a debt default.

Thus he said printed money is not free money.

https://www.dailymirror.lk/business/CBrefutesclaims-that-higher-rates-put-strain-on-government-funding/215-246621

https://www.srilankachronicle.com

ChooBoy


Senior Manager - Equity Analytics
Senior Manager - Equity Analytics

Interest rate hikes are not the answer to inflation problem

Rising inflation throughout 2022 has resulted in central banks substantially increasing interest rates. Patrick Kaczmarczyk argues that rate hikes are the wrong response to the challenges currently facing the European economy.

Inflation rates across the Eurozone are putting the European Central Bank (ECB) under pressure to raise rates – whilst economic indicators continue to nosedive. The ECB seems nonetheless determined to do “whatever it takes” to bring down inflation, even if “whatever” were to imply a severe recession and permanent damage to the European economy.

When we look at the history of rate hikes by the ECB, we may expect that the story will not end well. In 2006, the ECB started to increase its interest rates throughout the troubling years of 2007-08. The cause of the inflationary pressures back then was a sharp increase in oil prices, which peaked at close to $150 per barrel in early 2008. The tightening of monetary policy by central banks triggered the bursting of the bubble on financial markets, which was followed by the then largest crisis of modern capitalism. Central banks were forced to take a U-turn in monetary policy to accommodate policymakers in their efforts to halt the meltdown of the global economy.

After the financial crisis and the crash of commodity prices, a reverse cycle set in, and commodity prices started to shoot through the roof again. Oil prices almost tripled between January 2009 and April 2011, food prices joined the rally (wheat prices, for example, doubled in the same period). Inflationary pressures re-emerged, whilst the Eurozone found itself in the deeply troubled waters of the Eurozone crisis. ECB president Jean-Claude Trichet, along with certain members of the Governing Council, prioritised the fight against inflation over financial and economic stability – and the ECB started to raise interest rates amidst another crisis. We know in hindsight that the ECB had to step in again – this time under the leadership of Mario Draghi – with another U-turn to prevent the Eurozone falling apart.

This time is different?

Today, the ECB finds itself between a rock and a hard place. Throughout 2021, it argued that inflation would be transitory. The data at the time were clear: wage growth was subdued, inflation was driven largely by broken supply chains, and, from the autumn of 2021 onwards, also by rising energy prices.

In 2022, the energy price rally continued to new record heights, triggered by shortages due to Russia’s invasion of Ukraine and amplified by financial speculation. Additionally, still broken supply chains and recurring Covid-lockdowns have continued to disturb global production. Hence, we ought to conclude that the sui generis and transitory factors creating inflationary pressures in 2021 have increased in strength and now drive inflation in 2022. As Martin Sandbu put it earlier this year, “the fact that we have had one unforeseen supply shock after another — which nobody disputes — is not a reason to think each of them is not transitory.”

However, the longer high inflation rates persist, the more it appears they may have become somewhat permanent. As a consequence, the ECB finds itself under increasing pressure from policymakers, the media, and the public. Although energy prices are pushing many firms to the verge of closure, and virtually all economic indicators are in freefall – partly indicating that we are heading towards a crisis of a larger scale than 2008 and the Covid-19 pandemic – the ECB finds itself cornered to take a tough stance.

Based on a sober assessment, we would have little reason to expect inflation rates to continue to rise next year. Wage growth remains subdued in the Eurozone and given that firms are under high pressure due to extremely high energy prices, there is little room for negotiating large wage increases. The outlook for energy prices, the main driver of the current inflation, also appears to have a smoothing effect on inflation next year, as energy futures point towards a gentle decline of prices from Q2 2023 onwards.

At this point, it is hard to see where further momentum for similar inflation rates next year should come from. However, even if inflation rates were to slow down in 2023, it is unlikely that we will have overcome the current shortages, and the overall high price level will continue to squeeze households and businesses. Considering how badly the interest rate hikes in previous periods turned out in the Eurozone, interest rate hikes in the current environment promise to add fuel to a fire we are struggling to contain.

Different times require different approaches

In Europe, most economists acknowledge that inflation is not driven by expansionary fiscal or monetary policy. It is not an overheating of the economy that requires some cooling. Quite the contrary: the current inflationary pressures spread throughout an economy that is freezing cold. In such a context, monetary policy tightening is the least suitable tool to address the current challenges.

If we compare the figures in two structurally similar economies, the Czech Republic and Slovakia, we come as close to a difference-in-difference experiment as possible for examining the effectiveness of monetary tightening. The Czech Republic increased its interest rate from 0.5 percent to 7 per cent between the summers of 2021 and 2022, whilst inflation continued to climb from less than 5 to over 17 per cent. Slovakia, as a member of the Eurozone tied to the monetary policy of the ECB, had no similar increases in interest rates, yet its inflation went – during the same period – from similar levels of less than 5 percent to around 14 per cent. This confirms in a way what Isabel Schnabel, member of the Governing Board, recently admitted, in that the “[ECB’s] monetary policy has little impact on what is happening on global commodity markets”.

If the ECB has little impact on what happens on global commodity markets, the only way in which monetary policy can bring down inflation is via introducing an economic downturn. The likelihood of such a downturn is further exacerbated by a widespread turn to austerity. Adam Tooze has pointed out that currently, there are more countries tightening the fiscal screws than there were during the global turn to austerity in 2010. The very recent announcement of the German government of its €200 billion package to bring down energy prices as well as the slightly softer stance of the EU towards debt reduction are two hopeful indicators that governments will turn away from such a dangerous shift towards austerity.

Despite the latest shift, some economists continue to argue that if there is a supply shock, we need to adjust the level of demand downward. However, this logic is akin to flooding an entire house to extinguish a fire in the kitchen. What this peculiar type of inflation requires, indeed, is investment to overcome the existing shortages. Instead of bringing down demand in a fragile economy, we need to expand the supply. In the 200 years of capitalism, if there is one feature that cannot be denied, it is that investments and innovation have always been the key to overcoming real shortages.

In the current environment, this is of course not simple and could mean that, in the short run, inflationary pressures could persist. In the medium to long run, however, when the investments and innovations start to bear fruit, Europe would be a lot better off as a society and economy. Opting for a strategy of austerity, by contrast, offers no solution – neither short-term nor long term – to the problems we face.

How we should proceed

The most urgent investment needs concern the scaling up of renewable energy and other alternative forms of energy that we can use in the short run. The primary goal of economic policy must be to expand the energy supply to bring down energy prices. At the same time, the state must take the lead and incentivise the private sector to invest in innovations that increase energy and resource efficiency as well as the circularity of production and consumption.

Such investments must complement short-term measures to stabilise household purchasing power and halt the meltdown in demand that we are currently observing. Otherwise, the political and economic fallout from this crisis will increase the cost beyond values that we can put a price tag on.

Finally, the perfect storm we are facing underlines the need for international economic cooperation. The response to this global crisis so far has been uncoordinated and risks wrecking the global economy. During the Great Depression in the 1930s, countries embarked on widespread beggar-thy-neighbour policies, where each state tried to increase its competitiveness vis-à-vis a currency depreciation. Today, we are witnessing the opposite, as countries pursue an uncoordinated race to the top in interest rates to lower imported inflation by halting currency depreciation.

The tightening by the Federal Reserve has forced other countries to follow suit as the high interest rate differentials and the status of the US dollar as the world’s reserve currency prompt capital flight to the US. The consequence has been a strong appreciation of the US dollar, generating more expensive import bills for the rest of the world, which the latter, in turn, have tried to halt by raising interest rates themselves. The Global South, in particular, is now facing financial disaster as interest rates go through the roof and the burden of dollar-denominated debt threatens to suffocate already struggling economies.

In 1985, the US took the initiative to rectify some of the emerging imbalances in foreign exchange markets and subsequent trade imbalances. The result was the historic “Plaza Accord”, following which Germany and Japan allowed for significant currency appreciation. This time, central banks and policymakers from around the world ought to get together and intervene in foreign exchange markets in a similarly coordinated way. This would reduce the pressure to compete over who can offer the fastest and highest rate hikes. Unfortunately, there are no signs that such a coordinated approach to solving the crisis is on the horizon. International cooperation appears to be at its lowest point, right at the time when it is so desperately needed.

Note: This article gives the views of the author, not the position of EUROPP – European Politics and Policy or the London School of Economics. Featured image credit: Sérgio Garcia | Your Image | European Central Bank (CC BY-NC-ND 2.0)

ChooBoy


Senior Manager - Equity Analytics
Senior Manager - Equity Analytics

How interest rate hikes impact your money and the economy

MANILA, Philippines – The Bangko Sentral ng Pilipinas (BSP) on Thursday, September 22, raised interest rates by 50 basis points, as inflation is seen to rise higher than previously expected.
This brings the key policy rate to 4.25%, in line with analysts’ expectations, following the United States Federal Reserve’s aggressive hike of 75 basis points. The Fed reiterated that it may raise rates even more.

The hike comes as the Philippine peso hit the P58 level against the dollar, the lowest ever.
Average inflation for 2022 is still projected to breach the upper end of the 2%-4% target range at 5.6%. The forecast for 2023 has also increased slightly to 4.1%, while the forecast for 2024 eased to 3%.
Other Stories.

“The risks to the inflation outlook remain tilted toward the upside until 2023 and broadly balanced in 2024. Price pressures may continue to emanate from the potential impact of higher global non-oil prices, pending petitions for further transport fare hikes, the impact of weather disturbances on prices of food items, as well as the sharp increase in the price of sugar,” the BSP said.

How it affects you
Central banks raise interest rates to curb inflation. Doing so would discourage companies and consumers from spending, and in theory, bring prices down.

Here’s how that will impact your money:

Credit cards – A higher interest rate set by the BSP means higher interest you need to pay for outstanding debt of credit cards not paid off by the due date.

Auto and housing loans – Current rate hikes don’t affect your auto and housing loans if these loans are on a fixed-rate basis. But new loans or loans with variable-rate financing will be more expensive.

Savings – Interest rate hikes encourage people to save, but it will take time for banks to implement higher deposit rates. It is best to check with your bank if it has increased deposit rates. Higher inflation, however, cancels out this benefit.

What it means for the economy
According to economists of the Asian Development Bank (ADB), rising interest rates shrink global liquidity and slow down economic recovery from the pandemic.

The ADB said that for businesses, a tighter credit environment results in higher borrowing costs, reducing their profitability and investment incentives.

“As borrowing costs rise, households are also less inclined to spend, especially on durable goods and houses. Softening demand and weaker global growth pose challenges for Asian manufacturing and exports,” the ADB said.

Monetary tightening by the US Fed encourages investors to pull out their money from Asian economies, leading to currency depreciation.

While Philippine households reliant on overseas remittances would get more cash due to the peso hitting P58 against the dollar, currency depreciation increases inflationary pressures.

Remember, the Philippines is very dependent on imports like food and oil. Import costs rise due to the stronger dollar, effectively worsening the country’s current account balance.

It also negatively impacts the country’s payments of essential imports and infrastructure, as well as the servicing of external debt.

“This shows that higher inflation associated with increases in commodity prices poses complex challenges to monetary policymakers, forcing them to wrestle with the two conflicting objectives of price stability and higher growth,” the ADB said. – Rappler.com

https://www.rappler.com/business/how-interest-rate-hikes-impact-money-economy/

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