Anomaly in Wijewardena’s ‘Hidden Anomaly’ article

Friday, 10 October 2014 11:31 -     - {{hitsCtrl.values.hits}}

Wijewardena has expressed strong views on the Central Bank’s latest monetary policy review in an article titled ‘Central Bank’s Monetary Policy Review: Is there a hidden macroeconomic anomaly?’ While appreciating his views, in order to understand this issue in a holistic sense, it may be appropriate to consider whether there are any hidden anomalies in Wijewardena’s views, as well.  

Unconventional measures

According to Wijewardena, the latest Central Bank monetary policy action is a “penalty” imposed on banks for their “wrong” behaviour. However, any person with knowledge in monetary economics would observe that this recent action of the CB is an easing of monetary policy, albeit using an unconventional method, in this day and age where many unconventional monetary policy measures are being used by central banks, worldwide. In this instance, Wijewardena may also perhaps recollect that a similar method was used by the Central Bank to tighten monetary policy during the 2008/09 period, when he was the chairman of the Central Bank’s Monetary Policy Committee. In that context, it is strange that Wijewardena now has difficulty in understanding the nature of the recent monetary policy measure which is an obvious anomaly in his argument.  

Private sector credit

Also, according to Wijewardena, lower growth in private sector credit, at a time when there is overall growth in the economy, is a freak outcome. Of course, on the face of it, that may appear as an unusual outcome to a layman who is not an economist, but as all students of monetary economics know, private sector credit is only one component of the overall monetary expansion. In that context, Sri Lanka’s overall monetary expansion has been growing at around 12%, which is consistent with real growth of around 7.5% and average inflation of around 4.5%. Further, after the substantial expansion in private sector credit during 2010 and 2011, the base of the outstanding private sector credit has been significantly high, and the subsequent lower growth on that higher base is therefore not a reason for a lower contribution of the private sector credit growth towards overall economic growth in 2013 and 2014. It is also a fact that Sri Lanka’s private sector credit outstanding is still around a low 30% of GDP which indicates that there are various other alternative sources in the country to finance growth. One of such sources during the last couple of years has been the external financing by the Government, corporates, banks and private sector. This emerging feature in the economy has been a key reason as to why the overall monetary expansion has been in line, and consistent with growth and inflation figures. Unfortunately, Wijewardena seems to have ignored this aspect, and that is probably why he has compared some incomparable figures relating to a few sectors of the economy, and arrived at a finding which is not borne out in the context of Sri Lanka’s overall macroeconomic situation.  

Factory Industry Production Index

In his article, Wijewardena has compared the Factory Industry Production Index (FIPI) with the value addition of factory industry output, specifically in relation to wearing apparels as compiled by the Department of Census (DCS). In this regard too, research on these indices show that Wijewardena’s comparison seems to be erroneous due to several reasons. First, the FIPI compiled by the Central Bank is a volume index, based on factory industry production data, whereas the DCS measures the factory industry output using value addition of factory industries. As is quite possible, and as Wijewardena would probably know very well, two institutions could use different sample frames to collect data, as well as use different methodologies to measure the performance of a particular sector. Therefore, differences would invariably be seen, although similar trends could be expected in the data published by both institutions. Second, Wijewardena compares the first half factory industry value addition data with year-on-year factory industry production data of FIPI for May 2014. Such a comparison is not only erroneous, but misleading. For an accurate comparison, it is obvious that it would be necessary to consider the same reference period. In that background, it would be best for Wijewardena to wait until the June data is published to make a proper comparison, and to see whether both indices reflect similar trends. Third, in the context of the contribution of the wearing apparels sector to the overall GDP beingonly around 3%, Wijewardena’s observation of its impact on overall GDP growth, even if his analysis is correct, will not be significant enough to have a material impact on the overall growth figures.  

Construction industry

Wijewardena also sees an anomaly in the construction industry which he claims as being due to the import of building materials, vehicles, machinery and equipment declining by 14% in the second quarter on 2014, compared to the relevant quarter in the previous year, although the sector’s value addition has increased by 20%.In this regard too, what Wijewardena has failed to appreciate is that during 2011 and 2012,a significant increase in the imports of investment goods including building materials, vehicles, machinery and equipment, took place. Generally, such investment goods enjoy a long life span, and hence such assets could be used for construction activities over several years. Hence, there could be a deceleration in such imports after a prolonged period of high investment, since the industry already carries a large inventory of construction equipment and materials. Further, imports of this nature may also be used for production (here construction) with a time lag. Therefore the direct comparison of imports and local value addition of the construction industry is an obvious anomaly in Wijewardena’s logic.  

Zero interest rate regime

Wijewardena also raises the question as to whether Sri Lanka will move towards a zero interest rate regime like Japan, EU, the UK and the USA. While there does not seem to be any reason for the Central Bank to move towards such a low level, there has also been no Central Bank action or communication to even remotely suggest that interest rates would reach, or be lowered towards, such levels. Hence, the new Wijewardena hypothesis does appear not to be based on any economic logic. Finally, albeit reluctantly, it must be stated that from the time Wijewardena retired from the Central Bank, the Central Bank seems to have been able to secure low and stable inflation, deliver reasonable positive real interest rates, and maintain a relatively stable currency. As a result, it is quite possible that Wijewardena may now be ruefully reflecting on what he should or should not have done during the time when he was the Chairman of the Monetary Policy Committee to bring about such benign results. He may also be feeling somewhat uncomfortable at the thought that during those days when he was at the helm of affairs, notwithstanding all his efforts, the country suffered from serious double-digit inflation, negative real interest rates, over 100%, debt to GDP levels, and a public perception that the Central Bank was unable to deliver favourable macro-fundamentals. However, in direct contrast today, all market players, international investors, rating agencies, and international banks are showing strong faith in the Central Bank administration, and there is a high level of confidence in the economic outlook. That perception may perhaps explain why Wijewardena is looking for anomalies in the current monetary policy actions which are continuing to yield successful results to the economy.