By Mandana Ismail Abeywickrema

While the country's inflation rate has declined for the first time this year to 26.6% in July from a record high of 28.2% in June as per the custom designed new index, the excessive expenditure of the administration is exerting continuous pressure on the inflation rate.

Although the government announced the decline in the inflation rate from 28.2% to 26.6%, it still remains the highest inflation rate in the region.

Inflation dipped to 26.6% in July from a record 28.2% in June. Prices rose 0.2% in July compared with an increase of 3.7% in June according to the Colombo Consumer Price Index (CCPI).

The moving average for July is recorded at 21.9% compared to 21% in June.

This has been attributed to the reduction in food prices, consumer spending and low growth.

The country's inflation rate has been on the increase since last year mainly due to the loose monetary policy followed by the Central Bank. However, the Central Bank tightened its monetary policy this year and has stated that the inflation rate should moderate towards the latter part of the year.

Pessimistic

Analysts however have been rather pessimistic and say that although the Central Bank has so far tightened monetary policies, it has found it difficult to rein in inflation as the policy interest rate has been kept far below inflation at 12%.

Professor of Applied Economics at the Johns Hopkins University,  Baltimore and a Senior Fellow at the Cato Institute, Steve H. Hanke earlier in the year stated that the spectre of unanchored inflation haunts the Sri Lankan economy.

He states that if the civil war flair-up wasn't bad enough, Sri Lanka's other major problem - the bogey of inflation - remains alive and kicking. Inflation has been spiralling up since the start of 2006. Last year ended with a disturbing 18.8 % year-over-year increase for the month of December.

Those unanchored expectations, according to Hanke have thrown into doubt the Central Bank's 2008 inflation target of 10% to 11%.

He adds that in light of the huge fiscal deficits that have been recorded year-after-year and with the civil war heating up, it will be very difficult to control inflation and sustain strong growth with Sri Lanka's current monetary set-up.

"To slay the inflation bogey, Sri Lanka needs new institutions that will deliver discipline," he stated.

He explains that at the end of the day, inflation is always a monetary phenomenon. This is, of course, the case in Sri Lanka. The problem resides at the Central Bank. It doesn't have a credible anchor. In consequence, it lacks the discipline to control inflation and contain inflation expectations.

Lack of discipline

Analysts say that mostly the lack of discipline of the Central Bank and the printing of large sums of money to fund unproductive expenditure by the government have been the root causes of the high inflation.

It has been reported that between May and September 2007, the Central Bank printed Rs.49 billion (the equivalent of US$457 million). This according economists was a clear indication of the bank's non compliance with financial discipline.

Even the IMF's country report on Sri Lanka for 2007 had said that a "pause in monetary tightening during July-August had contributed to the acceleration in inflation."

Meanwhile, a recent analysis by top-level economists attached to HSBC had revealed that inflation in Sri Lanka was largely a fiscally caused, monetary phenomenon because the large fiscal requirements of the government were met by the Central Bank printing money.

However, the Central Bank has continuously denied its role in fuelling inflation by pumping too much money into the market.

Denies reports

While the Central Bank denied reports of excessive money printing, Trade and Consumer Affairs Minister Bandula Gunawardena in an interview with the BBC last year stated that the government had no option but to continue to print money to meet its expenses and that it has resorted to printing money to cover budget deficits that had resulted in 'excessive' inflation.

It is this level of inert confusion within the government, which former Consumer Affairs Minister Ravi Karunanayake described recently in parliament as "the left hand not knowing that there is a right hand, never mind what it is doing!" that has made it impossible for the government to stick with one steady and strong fiscal policy.

The government in its Mid Year Fiscal Report 2008 admitted to the financial crisis faced by the country with an increase in the budget deficit and domestic borrowings to bridge the deficit given the decline in foreign grants received by the country and a revenue shortfall.

The Mid-Year Fiscal Report 2008 stated that the overall budget deficit has increased by almost 26% in the first four months of this year compared to the corresponding period last year.

An analysis of the Finance Ministry's Mid Year Fiscal Report  2008 has also indicated a drastic drop in foreign grants and loans during the first four months of this year compared to the same period last year compelling the government to rely more on domestic borrowings.

However, as reported time and again, the present administration has shown no real interest in reducing its large expenditure bill.

Amidst the already high spending spree, the government has also increased its expenditure bill by adding on to it a wage hike for the bloated public sector.

The Treasury Secretary in a circular dated July 18, 2008 has announced revised cost of living payments to be effective from July 1, 2008.

Allowance increased

According to the circular, employees who received a monthly salary less than Rs.25,640 and a cost of living allowance of Rs. 2,500 under the Management Services Circular No.30 are to receive an increased cost of living allowance of Rs.3,500 from July 1, 2008.

Workers receiving a salary above Rs.25,640 are to receive a cost of living allowance of Rs.2,875 from July 1, 2008.

The circular also states that a daily wage earner could be paid Rs.116.66 on a daily basis or a payment not exceeding Rs.3,500 as cost of living allowance from July 1, 2008.

Analysts point out that the government has granted a wage hike when the government earns a revenue of Rs.750 billion, of which, Rs.580 billion is paid as loans and interest payments, and the state is left with only Rs.170 billion.

They have further stated that allocation for defence expenditure for the year also stands at Rs.170 billion, which leaves the government grappling for funds to meet other expenses including salaries of the public sector workers (excluding members of the armed forces and police) and other welfare payments.

The real test before the government now is to sustain the decline recorded in the inflation rate last month given the many economic challenges before it.