An Individual project given in order to complete the module named Macro Economics which expresses analysis of the trends of inflation rates of Sri Lanka during recent years.

1. Recent Trends in
Inflation Rate of Sri
Lanka
Macroeconomics Project
30th
July 2014
Prepared by:
Ajutharsan S.
(ADBM-F-131008)
Advanced Diploma in Business Management (Full Time) – 13.1 Batch

2. 1
Recent Trends in Inflation Rate of Sri Lanka
Contents
Recent Trends in Inflation Rate of Sri Lanka......................................................................1
Introduction to Inflation.......................................................................................................2
Consequences of Inflation ...................................................................................................3
Types of Inflation.................................................................................................................4
Measures of Inflation in Sri Lanka ......................................................................................4
Recent Inflation Rates in Sri Lanka.....................................................................................5
In Year 2008 ....................................................................................................................6
In Year 2009 ....................................................................................................................6
In Year 2010 ....................................................................................................................7
In Year 2011 ....................................................................................................................7
In Year 2012 ....................................................................................................................8
In Year 2013 ....................................................................................................................8
Suggestions in order to minimize the problems related to Inflation of Sri Lanka...............9
Conclusion ...........................................................................................................................9

3. 2
Introduction to Inflation
Inflation occurs when the general level of prices is rising. Today, the inflation is
calculated by using price indices-weighted averages of the prices of many individual
products. The consumer price index (CPI) measures the cost of a market basket of
consumer goods and services relative to the cost of that bundle during a particular base
year.
If the inflation is able to forecast easily, then it is hard to imagine how inflations or
deflations may cause critical economic problems. In this case, nominal prices could be
contractually agreed upon in a way that goes beyond the primary real prices (including
wages and interest rates) at their correct levels. Inflation is not always able to forecast
easily. This appears to be generally true for economies experiencing very high rates of
inflation. It is a fact of life that most contracts are declared in nominal terms and that
these terms depend on the forecast of inflation. If inflation is highly variable, it is not easy
for nominal contracts to make sure the proper allocation of real resources. Unexpected
inflation is viewed as being undesirable for two reasons. First, if contracts are not guided
to inflation and if contracts are costly to re-negotiate, then an unexpected inflation results
in a redistribution of resources (for example, from creditors to debtors). Second, if
indexation and/or re-negotiation are costly, then inflation uncertainty is likely to involve
resource costs and the limitation of economic activity.

4. 3
Consequences of Inflation
 Income redistribution: One risk of higher inflation is that it has a regressive effect on
lower-income families and older people in society. This happen when prices for food
and domestic utilities such as water and electricity rise at a rapid rate.
 Fall in real incomes: With millions of people facing diminish in their wages or
paying less to them.
 Negative real interest rates: If interest rates on savings accounts are lower than
inflation, people who rely on interest from their savings will be lower. Real interest
rates for millions of savers have been negative for at least four years.
 Cost of borrowing: High inflation may also lead to higher interest rates for businesses
and people needing loans and mortgages as financial markets protect themselves
against rising prices and increase the cost of borrowing on short and longer-term debt.
There is also force on the government to increase the value of the state pension and
unemployment benefits and other welfare payments as the cost of living climbs
higher.
 Risks of wage inflation: High inflation can lead to an increase in pay claims as people
look to protect their real incomes. This can lead to a rise in unit labor costs and lower
profits for businesses.
 Business competitiveness: If one country has a much higher rate of inflation than
others for a considerable period of time, this will make its exports less price
competitive in world markets. Eventually this may show through in reduced export
orders, lower profits and fewer jobs, and also in a worsening of a country’s trade
balance. A fall in exports can trigger negative multiplier and accelerator effects on
national income and employment.
 Business uncertainty: High and volatile inflation is not good for business confidence
partly because they cannot be sure of what their costs and prices are possibly to be.
This uncertainty might lead to a lower level of capital investment spending.

5. 4
Types of Inflation
The modern economic theory describes three types of inflation
 Cost-push inflation
Cost-push inflation is due to wage increases that cause businesses to raise prices to
cover higher labor costs, which leads to demand for still higher wages (the wage-price
spiral)
 Demand-pull inflation
Demand-pull inflation results from increasing consumer demand financed by easier
availability of credit.
 Monetary inflation
Monetary inflation caused by the expansion in money supply (due to printing of more
money by a government to cover its deficits).
Measures of Inflation in Sri Lanka
Inflation is measured using a number of indices such as Colombo Consumer Price Index
(CCPI), Colombo District Consumer Price Index (CDCPI), Greater Colombo Price Index
(GCPI), Wholesale Price Index (WPI) and Sri Lanka Consumer Price Index (SLCPI). The
CCPI is the official measure of price changes with food items representing 62 per cent,
clothing 9 per cent, fuel and light 4 percent; rent 6 per cent, miscellaneous 19 per cent in
total weights. Food is an important item in all of the indices representing relatively larger
portion in all of the above mentioned baskets.

6. 5
Recent Inflation Rates in Sri Lanka
Year Jan Feb Mar Apr May Jun Jul Aug Sep Oct Nov Dec Annual
Average
Inflation
Rate
2013 9.80
%
9.80
%
7.50
%
6.40
%
7.28
%
6.84
%
6.06
%
6.34
%
6.22
%
6.73
%
5.62
%
4.69
%
6.94
%
2012 3.75
%
2.71
%
5.44
%
6.11
%
7.00
%
9.26
%
9.89
%
9.52
%
9.10
%
8.91
%
9.50
%
9.20
%
7.53
%
2011 6.27
%
7.23
%
7.73
%
8.82
%
8.14
%
7.08
%
7.44
%
7.00
%
6.38
%
5.14
%
4.74
%
4.89
%
6.74
%
2010 7.09
%
7.55
%
7.13
%
6.79
%
5.66
%
5.14
%
4.44
%
4.97
%
5.71
%
6.50
%
6.90
%
6.82
%
6.22
%
2009 10.45
%
7.45
%
5.24
%
2.61
%
3.59
%
0.75
%
1.20
%
0.97
%
0.97
%
1.58
%
2.95
%
5.03
%
3.56
%
2008 20.88
%
21.62
%
23.67
%
24.92
%
25.80
%
28.31
%
26.63
%
24.83
%
23.90
%
19.86
%
16.03
%
13.88
%
22.53
%
Source: http://www.gdpinflation.com/2013/05/inflation-rate-in-sri-lanka-from-1988.html
0.00%
5.00%
10.00%
15.00%
20.00%
25.00%
2007 2008 2009 2010 2011 2012 2013 2014
Average Annual Inflation

7. 6
Above figure shows the trends of inflation in Sri Lanka during the past six years period,
expressed as the annual percentage change in the Colombo Consumer Price Index
(CCPI). According to the above economic analysis, inflation rate in Sri Lanka has been
unstable. As measured by the Colombo Consumer Price Index (CCPI), in 2008 the
inflation rate recorded was at a peak of 22.6 percent. But in 2009 it decreased up to 3.56
percent. Since 2009, the rate increased gradually until 2012. However, in 2013, the
inflation rate decreased to 6.94 percent.
In Year 2008
The rapid rise in world commodity prices during 2008, most mainly fuel and food prices
corresponded with a sharp increase in inflation in Sri Lanka during the first half of the
year. The delayed effect of unfavorable monetary conditions that had been overcome in
the past as well as adverse developments in commodity prices contributed to the increase
in the index values in the first half of 2008. The increase in consumer price index during
the first half of the year was also fuelled by the low supply of domestically produced
agricultural commodities and the very high prices of imports, mainly food items, crude oil
and petroleum products, in the international market. The upward reviews of the fuel
prices, in late May 2008, had a significant impact on the flow in the level of CCPI.
In Year 2009
The effect of inflexible monetary policy adopted by the CBSL during the previous two
years and the decline in commodity prices in the international market attached with
improved domestic supply conditions and the downward review of controlled prices
assisted the rapid deceleration in inflation. Inflationary force applied through increase in
wages of public and private sector employees was contained through favorable
developments in supply side factors, improved labor productivity as well as the discreet
monetary policy followed by the CBSL.

8. 7
In Year 2010
The relatively low and stable level of inflation during the year was mainly attributable to
the improved domestic supply conditions and supportive fiscal policies assisted by the
adjustment in import duties, and downward reviews in controlled prices as well as the
position of discreet monetary policy. In addition, the relatively stable exchange rate and
improved productivity also helped lower price forces during the year. Meanwhile, the
core inflation, which is derived by excluding food and energy items from the CCPI
basket, followed a decelerating path both in terms of annual average basis in 2010.
In Year 2011
The relatively high inflation observed during the first few months of the year was mainly
due to an increase in prices as a result of supply disturbance caused by adverse weather
conditions that overcame in major cultivation areas. Although the price escalation due to
supply disturbances was temporary, the increase in inflation on a year-on-year basis
remained for a few months due to the low base in 2010. Further, several upward reviews
of controlled prices, especially of L.P.Gas and petroleum products during the year also
impacted directly and indirectly on inflation, at unstable powers. The real wage increases
during the year also applied some force on prices from the demand side. However,
considerable improvements in the domestic supply conditions attached with the control of
prices of food commodities in the international market, a relatively stable exchange rate
helped contain inflation in 2011. Gentle inflation expectations also helped contain any
unnecessary force on the general price level.

9. 8
In Year 2012
The relatively lower inflation observed during the first few months of the year was due to
the improved domestic supply of food items and a moderation in international prices of
imported commodities. The rising trend in inflation from the second quarter 2012 was due
to a number of factors, such as the upward reviews of controlled prices of petroleum
products, L.P.Gas, electricity and bus fares; the depreciation of the rupee; the increase in
duties on several imported commodities; and the increase in food prices due to crop
damage caused by both drought and floods. Although food price growths due to supply
disturbances were temporary, the low base that overcame in 2011 also contributed to
inflation remaining at higher levels. The real wage increases would have exerted some
cost and demand forces on inflation. However, improved supply conditions of agricultural
production, downward reviews of some controlled prices and duties on imported items
and demand management strategies together with managed inflation expectations helped
contain inflation at single digit levels throughout the year.
In Year 2013
The contribution to the decline in annual average inflation to 6.9 per cent in 2013 came
mainly from slowdown in the price increase in the Non-food category, which grew only
by 6.1 per cent in 2013 against that of 10.0 per cent in 2012. The impact of the upward
price revision of petrol, diesel, kerosene and bus fares on inflation was lower in 2013 than
in 2012. As a result, the average price in the Transport sub-category increased only by 4.6
percent. In addition, comparatively lower increase in the average prices in the sub-
categories of Health, Furnishing, Household equipment and routine household
maintenance and Clothing and footwear in 2013 than in2012 contributed favorably to this
decline. However, relatively high increase in the Food and non-alcoholic beverages
category by 7.9 per cent in 2013 compared to 2012 had an upward force on inflation.

10. 9
Suggestions in order to minimize the problems related to Inflation of Sri
Lanka
 As wage growth is a key factor in determining inflation, if wages increase quickly it
will cause high inflation. So government should try to limit wage growth.
 Increase the local productivity and export local products to international market and
gain foreign currency to local market.
 Improve the performance of aggregate supply in local market.
 Decrease the interest rate of financial loans and borrowings.
 Increase consumer interest rates to discourage borrowing and spending. And also
increase borrowing costs.
 Increase rate of mortgage to reduce people's disposable income.
 Government should set effective target for a low but positive rate of inflation.
Conclusion
It is identified that inflation is simply the percentage change of Colombo Consumer Price
Index (CCPI) which is the official price index in the country. It is identified that high and
unstable inflation can damage both individual businesses as well as consumers and hence,
to the economy as a whole. Constant inflation in goods and services can result in high
social costs, too. Thus the intension was changed in to forecasting of price levels in Sri
Lanka. Monetary policy practitioners are of the view that inflation is disadvantageous to
economic growth while it is believed that moderate inflation can contribute to economic
growth. The results highlight the need to put in place a stable macroeconomic policy in an
effort to maintain price stability, since low inflation would enhance economic growth in
Sri Lanka.