The Opposition and the inflation target

In October 2023, the current Central Bank Governor, Dr. Nandalal Weerasinghe, signed a Monetary Policy Framework Agreement (MPFA) with the then Finance Minister, Ranil Wickremesinghe, binding the Monetary Authority to maintain quarterly headline inflation (based on the Colombo Consumer Price Index (CCPI)) at 5%. The MPFA is a formal, legally mandated pact between the Minister of Finance and the Central Bank of Sri Lanka (CBSL), and it is one of the defining features of the Central Bank of Sri Lanka Act No. 16 of 2023, which was passed by Parliament as part of the many economic reforms recommended by the IMF.

Under the new Central Bank Act, the MPFA is subject to review once every three years, and the present agreement reaches its statutory review point in October 2026. Leading up to the next review, many economists have argued that the prevailing 5% target is too high and should be reduced to as low as 2%. However, the CBSL Governor has disagreed with those advocating a lower inflation target, claiming that Sri Lanka would have to compromise growth if it opted for a target as low as 2%.

Last week, this column extensively assessed the Governor’s observations in the context of the experiences of other economies and mainstream economic thought, concluding that a developing economy like Sri Lanka requires sustainable, non-inflationary growth driven by productivity, real capital investment and global competitiveness, rather than maintaining artificially low interest rate regimes or providing periodic fiscal stimulus that generates only short-term economic growth.

Meanwhile, National List MP Ravi Karunanayake, in a letter, requested President Anura Dissanayake to reduce the CBSL’s inflation target to 2% during the upcoming October review. The former Finance Minister stated that preserving purchasing power and protecting the value of the Rupee should be regarded not merely as technical monetary objectives but as fundamental pillars of economic and social policy.

However, some of the contents of his correspondence contradict reality and conventional economic wisdom. The controversial politician expressed his disapproval of the Monetary Authority’s practice of raising interest rates to bring down inflation. He argued that excessive reliance on interest rate adjustments alone may not address the root causes of inflation. In practice, however, interest rate policy, a key monetary policy instrument, remains highly effective in curbing inflation, and monetary authorities worldwide raise interest rates to contain price pressures. Hence, a paradox emerges: while calling for a lower inflation target, the CIMA-qualified accountant appeared to oppose raising interest rates, the principal tool monetary authorities use to reduce inflation. The eminent economist Milton Friedman famously said, “Inflation is always and everywhere a monetary phenomenon.”

The former UNP stalwart has a documented history of criticising the Central Bank whenever it raised interest rates to control inflation. In 2018, he publicly criticised the then CBSL Governor over high interest rates while championing the concerns of the business community. Karunanayake has also been a vocal critic of granting the Central Bank autonomy and independence in conducting monetary policy, an arrangement widely regarded as essential for maintaining price stability. Two months ago, in an interview with a daily newspaper, the former UNP Colombo North Organiser revealed that he had once told former President Ranil Wickremesinghe that the Central Bank should not have been granted the level of independence it currently enjoys. Reflecting what critics describe as a weak understanding of monetary economics, Karunanayake added that the Central Bank should also focus on economic growth and employment generation.

The qualified management accountant should recognise that the fundamental responsibility of a monetary authority is to ensure price stability and financial system stability. Karunanayake’s views on interest rates and Central Bank independence undermine the very foundations on which Sri Lanka’s economic recovery has been built.