ECONOMYNEXT - Sri Lanka is developing a price formula for fuel, Finance Minister Ravi Karunanayake said, raising the possibility that the economic strategy promoted by opposition legislator Wimal Weerawansa, which repeatedly destabilized the country, will end.
Karunanayake told reporters that a price formula for fuel has been developed and with some international input, but declined to say when it will be implemented.
Economists have been calling for fuel to be market priced for several years as energy subsidies funded by bank credit - which are then accommodated or re-financed by printed money by the Central Bank - has been a key trigger of past balance of payments crises and high inflation.
Wimal Weerawansa led a campaign backed by the Janatha Vimukthi Peramuna, from around 2002, labelled 'removing the plug' to abandon the price formula that had helped the rupee to be stable despite rising oil prices.
In 2003, the rupee rose to 94 to the US dollar from 97, and inflation was near zero, but in 2004, the rupee fell to 105 with 60 billion rupees being printed to finance fuel subsidies, and country-wide inflation rose towards 20 percent.
At the time, a Mercantilist economic theory that fuel prices cause inflation, rather than the Central Bank was widely spread. In types of fuel, politicians said diesel caused inflation rather than petrol.
In the 2007/8 fuel price surge, the rupee fell to around 118 to the US dollar, with foreign investors also contributing to an outflow as the rupee weakened.
In 2011/2012, Sri Lanka financed electricity subsidies with credit with the Ceylon Electricity Board and Ceylon Petroleum Corporation, borrowing over 200 billion rupees, which were also accommodated by the Central Bank with printed money through sterilized foreign exchanges sale.
Although foreign investors stayed put, the Central Bank cut rates in January 2011, and electricity prices were not raised despite a drought.
The rupee fell to 131 to the US dollar during the crisis. The International Monetary Fund suspended a programme and the then-administration raised fuel and electricity prices and floated the rupee to end a sterilized forex sale cycle. The IMF also followed domestic economists in asking the government to introduce price formulae in 2016, but it was not done.
However, each time the rupee falls, the rupee cost of imported energy goes up, requiring higher price hikes than if they had been raised earlier, helping prevent a currency crisis.
Currency crises are caused when the central bank resists rate increases with printed money as credit demand rises, driving credit and imports higher, panicking foreign investors and making exporters keep dollars abroad and fund expenses with domestic credit.
In 2015, the balance of payments crisis came as money was printed to finance a large budget deficit despite falling oil prices, and the Central Bank cut rates in April 2015, panicking foreign investors.
It also printed money not just to sterilize foreign exchange sales, but to keep markets flushed with excess liquidity in a bizarrely loose policy.
Borrowings by state-owned enterprises have started to move up over the last quarter of 2016, indicating that state enterprises are net borrowers.
Karunanayake told reporters that state energy SOEs were still contributing taxes and were not making losses in an overall picture.
However, to pressure the rupee, only overall credit demand has to go up. If the central bank prints money stop rates from going up, there will be pressure on the rupee.
Deputy State Enterprises Minister Eran Wickremaratne has already called for price formulae to be implemented as early as possible. (Colombo/Mar20/2017)