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Prices rise as Mahinda Economics unwinds

Electricity and fuel prices have shot up as Sri Lanka’s economy adjusts to the sudden drop in the value of the rupee after the Central Bank acceded to IMF pressure and abandoned – for now - its long standing policy of artificially propping up the local currency.

Diesel and kerosene prices rose 36 and 49 per cent respectively whilst electricity rates for domestic consumers are to rise by 40 per cent. Bakeries are threatening to increase the price of bread, a staple - especially for the working poor.

In the past two weeks the rupee has lost 5.7 per cent of its value against the US dollar. Consequently the prices of fuel and other imported commodities have risen.

At the same, the Central Bank is finally signalling an end to cheap credit from Sri Lanka’s increasingly state controlled banks – another key demand of the IMF.

Cheap state directed credit was an important factor in fuelling import demand - see our earlier post here.

These changes will hit hard President Mahinda Rajapakse’s support base – namely the middle and lower middle class, urban and rural voters in the Sinhala majority areas.

The UNP is already talking of an anti UPFA alliance with the TNA and JVP. However, economic difficulties may strengthen rather than undermine Rajapakse’s impeccable Sinhala nationalist credentials.

Losing value

The rupee’s loss in value reflects Sri Lanka’s precarious international trading position, a fact masked by the Central Bank’s repeated interventions.

In 2011, for example, the cost of Sri Lanka’s imports (US$ 18.4 billion), including crucially oil and food, was a staggering 190 per cent higher than the value of its exports (US$ 9.6 billion). See Central Bank figures here.

As a consequence of this imbalance there are always more people wanting to exchange rupees for dollars than the other way. Hence the fall in the rupee’s value against the dollar.

The drop would make it harder for ordinary people to buy food, fuel and other things.

Sri Lanka’s Central Bank has until this month tried to prevent the decline of the rupee by selling US dollars. In the latter half of 2011, for example, it sold US $ 2.5 billion to this end.

However, this policy was running down the Central Bank’s ‘reserves’ of dollars – made up mainly of worker remittances and, interestingly, credit lines from the IMF and others.

As dollar reserves continued to run down, the Sri Lankan central bank was forced earlier this month to abandon its policy of propping up the rupee.

The consequent surge in prices has already triggered popular protests. One person was killed and eight others critically wounded by police firing Wednesday at a demonstration against the fuel price hikes.

An end to cheap credit?

In yet another reversal of earlier policy the Central Bank also worked to limit the loans being made by commercial banks.

Sri Lanka’s banks have come under increasing state control and have been directed by their political masters to extend credit, particularly to the Rajapakse government and its supporters.

In 2011, the amount of credit extended by Sri Lanka’s banks to the private sector increased by 32.5 percent. Moreover, this expansion of cheap credit also fuelled import demand, accelerating the cycle.

The government’s policy reversals are likely to have an impact Rajapakse’s support base – namely middle and lower middle class urban and rural voters from the Sinhala south.

They have been the main beneficiaries of expanding private sector employment, fuel and electricity subsidies as well as enjoying cheap credit and subsidized imports.

See our earlier posts: 

Bank lending and ethnicity

Fears for the economy and of the state

'Learn Tamil, don’t employ Tamils'

Implications

But as Rajapakse’s Sinhala nationalist base is exposed its economic reality it is unclear where its anger will be directed.

The international community and sections of the UNP may hope for an anti Rajapakse mood. However, it is equally likely that the average Sinhala voter and consumer will instead blame – as they have done several times in the past - the Tamils and or the international community for their economic misfortunes.

But this has always been the case. Sinhala nationalism has for far too long been subsidised – and thus fuelled – by the international community’s optimistic tolerance of Colombo’s ethnically shaped economic and fiscal policies.

It is time the price of Sinhala utopia is paid by its main beneficiaries, rather than its victims.