Are interest rates declining due to low inflation?
(July 21, Ceylon Today) A weekly report pointed out that the basic explanation given by economists for the current historically low interest rates in Sri Lanka and their expected further reduction has been grounded on the sharp fall in the rate of domestic inflation.
Asia Securities Research said it is held that low inflation tends to safeguard the real value of savings and hence permits the rate of interest paid on capital to fall and remain low, following Fisher's formulation. However, it is a well known fact that the food prices in Sri Lanka have increased notably during the first half of 2014 despite CCPI inflation calculated by authorities indicating a sharp reduction. This can be attributed on one hand to the glaringly low base weight assigned to the food prices in Sri Lanka's 2006 base year CCPI compared to the peer economies in the region.
These peer economies on the other hand include the price of cigarettes and alcoholic beverages in CPI calculation; however, in Sri Lanka, despite their notable contribution to consumer expenses, cigarettes and alcoholic beverages are excluded in CPI calculation. The totality of these factors tends to undermine the effect of food inflation on the rate of headline inflation in the economy and reflects a lower inflation rate compared to the economies in the region.
Explaining further the report said, for instance if we take the base weight given for food items in Sri Lanka's CCPI out of total consumer expenses is 34.32% as opposed to 49.71% of India, 56.1% of Bangladesh, 43.96% of Vietnam, 42% of Nepal and 40.3% of Pakistan, which averages 46.4% for the economies considered above. This is to say that base weight assigned for food items in Sri Lanka's CCPI calculation is as much as 12.1 PPT lower than the average of the group of peer economies in view. The relatively lower base weight given for food prices in calculating the CPI in its turn tends to undermine the effects of food inflation on headline inflation and furthermore, tends to reduce it relative to the region.
It is interesting to note further that food prices in the Wholesale Price Index (WPI) of Sri Lanka (published only annually by the Central Bank) increased as much as 12.4% YoY in 2013 while that of the CCPI increased merely 3.5% YoY during the same period. If we consider that the values indicated by these two separate indexes are to be true this would mean that the retailers during the year bought dear from the wholesalers and sold cheap to the consumers! The totality of these developments indicate that headline inflation in Sri Lanka has not been low as reflected in the CCPI and on the contrary has increased notably. This is further affirmed by the significant increase in WPI food prices in 2013 as opposed to the abnormally low figure shown by the CCPI.
