Budget follows IMF guidelines
By R.M.B. Senanayake
As orthodox economists, we cannot criticise the macro-economic factors and balance underlying the Budget. The expenditure aggregate is limited in accordance with the government's inclination to raise tax revenue. So, if the government wants to spend more it will automatically have to tax more under IMF tutelage. Our governments generally do not like to raise taxes, although they like to increase government expenditure.
This means they run budget deficits and unless the deficit is met from the transfer of savings from the public (a limited option since our private savings are also low), they are then tempted to borrow money not only from the savings of the people, but also from the banking system (which is tantamount to the creation of new money) to fund budget deficits. So, a large quantity of new money is created without it being linked to any increase in the production process for goods and services.
Money is normally created through the production process when domestic production and exports exceed imports. The excess can then be accumulated as extra foreign exchange which can be converted to domestic money. Similarly, if exports fall short of imports there will be a shortage of domestic money. If we did not have a Central Bank, the money supply will vary with the balance in the balance of payments. All money was created only through the export and import process for money was linked to the surplus or deficit in the current account of the balance of payments. There were both advantages and disadvantages in the system since the domestic money supply varied with the external balance, providing an automatic correction to a balance of payments deficit. But it also meant the country had no control over its money supply.
The domestic economy which did not require imports was hampered thereby. It meant that the fluctuations in the external account automatically generated similar fluctuations in domestic aggregate demand which caused unnecessary fluctuations in domestic economic activity. Those who opposed it argued that there was no reason why domestic economic activity, which did not require imports should be curtailed. Theoretically, the criticism was valid, but in practice domestic economic activity was too highly linked to the external balance in any case.
So, when the nexus between the two was severed, this resulted in the build up of unsustainable domestic imbalances which required periodic devaluations and depreciations. Earlier, there were regular and continuous fluctuations in the exchange rate which automatically smoothed out imbalances in the balance of payments, but it meant continuous fluctuations in the exchange rate – a variable instead of a fixed exchange rate.
The IMF set up by world powers after the war, opted for fixed exchange rates except to correct periodic unsustainable imbalances in the balance of payments. So, countries were required to fix their exchange rates with the IMF and only if there were continuous unsustainable imbalances in their balances of payments were they allowed to depreciate the currency. There had been competitive exchange rate depreciations to promote exports by Western countries after World War I.
There are disadvantages in a freely fluctuating exchange rate since this could lead to speculative changes in demand and supply, whereas economists would prefer the exchange rate to be determined by fundamental factors instead.
After World War I, the exchange rate was linked to the external bank balances in foreign exchange. So, the exchange rates fluctuated with the external balances, but devaluations and depreciations raise the cost of living which make governments unpopular, but where there are continuous unsustainable deficits in the balance of payments, governments have no alternative, but to depreciate when necessary.
Since we are also a highly import dependent economy and consume many imported goods, our living costs can go up steeply due to changes in the exchange rate. So, a fluctuating exchange rate was not desirable for us. It would make living costs fluctuate too much.
It would also adversely affect our foreign trade. So, they opted for governments to stabilize and hold the exchange rates stable as far as possible, but this meant holding an adequate foreign reserve at all times. This task could not be left to the market and hence the Central Bank took over the task of holding the foreign exchange reserve of the country.
The commercial banks were allowed to hold only working balances of foreign exchange and not to hold or build reserves. So, any surplus over the working balances had to be sold by the commercial banks to the Central Bank, but there was merit in automatically linking the external value of the rupee to the external balance since it eliminated the need for the governments to undertake periodic devaluations which became explosive matters under independent democratic governments. Devaluation or depreciation raises the cost of living and was therefore, unpopular with the people.
But it may be necessary if there are unsustainable deficits in the balance of payments for otherwise the foreign reserves would be drained out completely and the country would become incapable of importing at all. So, conserving a minimum level of foreign reserves was a sine qua non since there was no automatic mechanism linking exports and imports. They are made by two different sets of people who are exporters and importers although a few may engage in both.
So, some public authority was required to regulate our foreign reserves and conserve a minimum level of them to provide for unforeseen eventualities. Export production for example could suffer due to adverse weather conditions, while continued imports would be required at the same level, but this would mean a shortfall in our foreign exchange balances, but we depend a lot on imported goods for our essential consumption requirements. At one time, we were importing rice, flour and sugar for our day-to-day requirements. And any shortage in the market for them would create public outcries and even bring down democratically elected governments. So, post-war democratically elected governments continued the government monopolies on the import and distribution of rice, flour and sugar.
The Food Commissioner was entrusted with the task and he had several large stores in the Chalmers Granaries and the Manning Market where these goods were stored and distributed through the cooperative unions who in turn sold them through cooperative societies.
So, the importing and distribution of rice, flour, sugar and even some subsidiary foodstuffs like Mysore dhal were made government monopolies or were mainly imported by the Food Commissioner and the cooperative wholesale establishments which were expected to act in the public interest rather than to exclusively pursue private profit.
Domestic money supply
As for the domestic money supply, there was much criticism in making it vary with the external payments position since some domestic economic activity could expend without causing problems in the balance of payments. This realization led to the demand for the setting up of a Central Bank which could create money to cater better to the needs of the economy without domestic monetary expansion being at the mercy of external demand.
During World War II, when we were under the British, our foreign exchange balances accumulated since imports were limited by enemy attacks as well as shortages of world supplies. So, our foreign exchange balances accumulated at the end of the war.
Our post-war independent government saw the opportunity to spend money freely to enhance their popularity and develop the country faster since they thought development depended on spending more money on investment. (this is true only if the investments are successful and increase incomes as a result)
World War II
Immediately after World War II we had a large volume of foreign reserves accumulated by denying expenditure. This has been used to undertake deficit budgeting funded by borrowings from the Central Bank and the banking system which economists refer to as the creation of new money. Such new money creation unlinked to the process of production or the surplus in the external account of the nation means more money is created while the supply of goods and services is not increased by domestic production.
So, the extra aggregate demand spills over to an increased demand for imported goods and services without a corresponding increase in exports. This results in an increased deficit in the balance of payments which has to be funded by drawing down foreign reserves of the country.
A certain minimum level of foreign reserves expressed in terms of the capacity for several months imports, say 5-6 months, is considered as a prudential level to deal with the fluctuations in world trade. Exports and imports don't match automatically in a free market economy since foreign reserves are used to fund the imports.
Exporters and importers are not the same people. The exporters are not allowed to keep the foreign exchange earned from their exports. They must surrender them to the banks and the latter in turn to the Central Bank (except for working balances).
The Central Bank becomes the holder of the foreign reserve of the country, built up from the surplus of exports over imports of goods, services and unilateral payments or receipts (such as remittances from our migrant workers). Only the Central Bank can keep unlimited amounts of foreign currency and the commercial banks are allowed to retain only working balances for their day-to-day operations. Let us conserve our foreign exchange earnings for a rainy day.
Solution must be acceptable to Tamils Separate State is not a reasonable request - Former Army Commander, General Gerry De Silva RWP, VSV, USP
- Beetle in Lankan tea shipment to Russia Exporter to be spared says Pethiyagoda
- Canadian Police probe ‘suspicious’ deaths of billionaire couple
- Stock Market Investor losses extend to Rs 94B
- Use of polythene in political rallies CEA to take on offenders
- Draft Legislation HRCSL advice not sought – UN Experts
- Drugs and drug users on the increase
- No NICs for 500,000 Lankans 300,000 are registered voters Bulk without birth certificates
- Growth decelerates to 3.3%
- UN damns Lanka 14,000 minors in childcare centres Calls for urgent reforms
- Russia restricts Lanka tea over beetle scare Top-level delegation off to Moscow
- Call to criminalize marital rape Justice Ministry seeks Cabinet approval
- Jumbo killings Armed protection unit to be set up Fines, jail terms to be increased
- Crossovers loom prior to polls
- SC issues notice on Elections Chief
- Jilted SLFP shuns JO forever
- CEB TU threatens strike Gives 18th as ultimatum
- Gnanasara Thera’s request for foreign travel denied
- Chinese envoy says OBOR will take Sino-Lanka ties to new level
- Police Chief in pre-poll warning Errant officers will be dealt with strictly
- Court extends Stay Order on Gota case
- Sriyani as State Minister of PCs and LG JO crossover pledged support for MS
- Rains to prevail Landslide warning to Galle, Kalutara to be reviewed
- BJP lauds ‘Ram Setu’ findings Hits out at critics
- Two held for impersonation at exam centre
- Female Genital Mutilation Advice sought from medical experts
- Visakhapatnam will favour the home team Batsmen to dominate decider
- Jadeja hits six sixes in an over
- Ntini’s son Thando in SA U-19 World Cup squad
- Neves stunner guides Wolves
- Westbrook nets triple double for Thunder
- Don’t see me making a WI comeback - Dwayne Bravo
- FIFA threatens to boot Spain out of World Cup
- SL lose two matches in T10s
- Army can dominate Air Force
- Smith and Marsh put attack to sword
- Sri Lanka play two Tests and Tri series in Bangladesh
- Chiefs winners in Kandy 10s
- Interesting battle at Havelock Park
- Thurstan win inaugural golf tourney
- History making Pulisic US men’s footballer of the year
- Knicks down Nets despite early exit for Porzingis
- 34th Mercantile Individual Tournament 2017 McLarens shuttlers Overall Champions
- Retired Hewitt takes tilt at Aussie Open doubles
- Lamborghini World Final 2017 Malagamuwa finishes third
- Committee clears Thilaka as SL coach
- Govt backtracks on anti-coal policy Two 600MW coal plants coming up
- Lankan company in pioneering global innovation
- Increasing worker remittances: Not a sign of prosperity
- Russian ban on Sri Lankan tea imports Navin to rush to Russia Ban comes into effect tomorrow, despite preventive efforts
- Dialog, RPC in CSE’s S&P SL20
- ADB loans Government US$ 270 million
- Japan expands unilateral sanctions against North Korea
- Purchasing Managers’ Index accelerates
- THASL educates Deputy Principals on Hospitality Management
- Financial Intelligence Unit signs MoU with Sri Lanka Police
- US Embassy & ICTA organize Knowledge Sharing Session
- CIM announces 2017 Board of Trustees CIM to be headed by leading marketing talent from across the industry
- Bolstering tourism: Starting from the top
- HNB wins two at CA Sri Lanka Annual Report Awards 2017
- Subhash Pinnapola launches ‘Storybook’ creative agency
- Mother Sri Lanka Movement launches series of activities
- Assets for debt, a flawed strategy
- Envisioning the future of Digital Banking
- Bank of Ceylon launches digital passbook
- Siyapatha Finance opens new branch in Panadura
- Protect Wilpattu Movement set in motion 5K strong turnout march in peaceful protest to UN office & handover petition
- Concretes & Abstracts Faith, Wayside Shrines & Urban Sprawl
- TGTE using Lawyers to challenge SL’s 6th amendment
- Christmas cheer is in the air!
- So, this is Christmas!
- New Land Draft BiLL Political wrangling hinders ironing out complex land issues
- We (don’t) need a Messiah Champika has failed to maintain what Mangala designed and Gota delivered
- M12M on the campaign trail Spotlight on polls and criminal elements
- Lord Naseby vs the Sri Lanka Campaign War is over, but body count debate continues
- Women’s quota in LG elections Historic opportunity Elect qualified, capable women– not wives & relatives of thugs
- Maithri should not sit in a Cabinet sans SLFPers
- Wigneswaran sowing seeds of communalism
- SLFP supports devolution of power – Lasantha Alagiyawanna
- If Bond scammers are not prosecuted…President will lose his credibility –Bandula Gunawardena
- All information security issues are not cyber crimes
- Sirisena Presidency - A Parallax View As foretold by Sobhitha Hamuduruwo
- Blessed are the peacemakers
- Disinformation campaigns and public mistrust
- Kemadruma Yoga An evil yoga cancelling all other favourable yogas
- Sun into Sagittarius ‘Kona Month’ has just begun
- Inviting wrath of goddess Lakshmi
- Five Yoga Poses to Calm Your Mind
- Rahu in 7th House and marriage
- The Disaster Artist: The (un)making of a movie
- Our children and our cinema
- INTERPRETING ASIAN CINEMA: CHALLENGES AHEAD
- How Sanskrit journalism is slowly hogging headlines
- ice manufacturing in South Asia
- CMSC’s season finale concert
- Two documentaries on Sri Lanka in Film South Asia 2017
- Politics of nostalgia
- Kite Surfing Lanka Kalpitiya An experience of a lifetime
- Ella and mini Adam’s Peak
- A cave of history -Ravana Cave
- I don’t get asked out
- Homemade apple & Chocolate Bodywash
- THE WRITER’S KITCHENETTE HOW THE GRINCH STOLE CHRISTMAS CUPCAKES Grinch Cupcakes
- New York Blast Terror charges filed against NY bomber
- Saga of Kohukumbure Rate Rala
- Attygalle murder and John Kotelawala Senior’s suicide