Something good, when everything’s bad
Sri Lanka is one of the “cheapest” countries to live, the Economic Intelligence Unit (EIU) says in its latest report on “Worldwide Cost of Living 2022”. This is crazy! We in Sri Lanka experienced the highest ever inflation, which is also the highest in Asia, reaching 70 per cent last September. But the EIU report shows that Sri Lanka is one of the countries in the world having the lowest cost of living.
In fact, the EIU report survey has covered the living costs in main cities, not the countries, so that for Sri Lanka it is Colombo. However, together with Sri Lanka the other countries with the cheapest living costs include India (Bangalore, Chennai and Ahmedabad) and Pakistan (Karachi) from South Asia, and Kazakhstan (Almaty) and Uzbekistan (Tashkent) from Central Asia as well as a few more countries from West Asia and Africa.
Inflation struggle
My friend, who forwarded the news to me also posed a question that many would ask: “How is it possible, when we have the highest rate of inflation in Asia?”
I answered: “It’s possible, if you earn in dollars, not in rupees!”
The EIU report acknowledged that many countries across the world are struggling with a costof-living crisis due to high inflation. On average, Worldwide Cost of Living prices have risen by 8.1 per cent this year, which is the highest rate of price increase over the past 20 years.
The most expensive country to live in the world is Singapore! Other expensive countries include the US (New York, Los Angeles and San Francisco), Israel (Tel Aviv), Hong Kong, Switzerland (Zurich and Geneva), France (Paris), Denmark (Copenhagen) and Australia (Sydney).
When the living cost across the countries is surveyed using a single currency unit, which is the US dollar, weaker national currencies would bring it down. Therefore, higher inflation and stronger national currency both make the living cost high. Even if the inflation is high, the weaker currency which depreciates against the US dollar makes the living cost low.
Dollar appreciation
Before we look at the exchange rate behaviour of other countries, let’s turn to examine the behaviour of the US dollar. During the first 10 months of this year (Jan – Oct), the US dollar has appreciated by 20 per cent, as per the US Dollar Index. In fact, the US dollar appreciation started in mid-2021, while it is at a “20-year high” now.
Along with the appreciation, the strong dollar can buy more of other currencies; in other words, other currencies can buy fewer dollars, because it is as same as other currencies that naturally become weaker. Because the US dollar is the most-traded international currency as well as the most-hoarded reserve currency for the world, its appreciation has far reaching consequences all around the world.
Why did the dollar become stronger? It was led by the change in interest rate policy by the US Central Bank, the Federal Reserve, in response to mounting inflationary pressure in the US. The rate of inflation, which was around 1 per cent at the beginning of 2021, started to rise reaching over 9 per cent in June 2022; although the rate has slowed down, it still remained at 7.7 per cent in October.
It was the time for any Central Bank to react with tight monetary policy. Accordingly, the Federal Reserve too started raising the policy rates or the Federal Fund rates. The lower and upper margins of these policy rates were 0.00 – 0.25 in the first quarter of the year 2022; they were raised seven times during the year, pushing them to 3.75 – 4.00 by the last month, November.
The increase in interest rates is aimed at reducing aggregate demand and, thereby taming the inflationary pressure. However, there is another policy implication; it also gives higher returns to US bonds. The yield on the 10-year US Treasury Bond increased from 1.50 per cent in the beginning of the year to over 4.20 per cent by November.
Thus, the international investors in stocks and bonds in other countries started shifting their investments to US financial assets.
Consequently, dollar outflows from other countries weaken their currencies, while dollar inflows to the US financial market strengthen the US dollar.
Weaker currencies benefit
The countries which had strong currencies due to better trade performance or greater foreign investment inflows or both could stand firm against the appreciating US dollar. The currencies of Singapore, Israel, Hong Kong, Switzerland and Denmark were countries with strong currencies, while the Euro and Australian currencies had actually appreciated during this period.
When a currency is strong, the rest of the world has to pay more to buy a strong currency. Even though there has been a moderate level of depreciation of some currencies against the US dollar, higher global inflation appears to have eroded the cost of living in dollar terms.
Sri Lanka had exactly the opposite of this scenario. There is no question that high inflation has wiped out real incomes of people, who find their cost of living has tripled or quadrupled within the past 12 months. Nevertheless, in US dollar terms it is much cheaper than before because the strong dollar can buy more rupees.
Just within three months in March – May, the exchange rate of the US dollar increased from Rs. 200 to Rs. 360, which is a depreciation by 80 per cent against the dollar. If we measure the cost of living in Sri Lanka using a common denominator such as the US dollar, it’s now much cheaper in dollar terms. Someone who received Rs. 100 by spending 50 dollar cents earlier can now buy it for 28 dollar cents.
Boosting exports
It is not incorrect to say that the cost of living in Sri Lanka is “cheaper” by international standards even in the midst of higher global inflation and a stronger US dollar. However, there is something noteworthy: Whether we turn around this situation for the benefit of the country is a whole different story.
As domestic inflation has already eroded our living standards so much, it doesn’t make any sense for people earning rupee incomes. In fact, the higher domestic inflation and currency depreciation have both been underlying causes of the deterioration of the living standards of the majority of Sri Lankans.
The main point that we need to get across is that the countries with “weaker” currencies can benefit from the strong US dollar because it makes the goods and services, they sell abroad cheaper. Accordingly, they can improve the international competitiveness of their produce for the world market against the competitor countries, which boosts exports.
At a time that Sri Lanka is faced with a foreign exchange crisis, this is an opportunity in the midst of all the challenges. While the business environment is attractive to export growth, it is the export growth which would enable the country to recover from the crisis and progress beyond the recovery.
Exports more than tourists
A weaker rupee against the US dollar benefits the tourism industry too because it would be “cheaper” for foreign tourists to choose Sri Lanka among competitor tourist destinations. However, we should not be overwhelmed by the potential revival of the tourism industry. Even if Sri Lanka would reach its 5 million tourists arrival targets soon, the country would not earn more than US$ 10 billion from it at a time when Sri Lanka needs to be generating 100s of millions of dollars.
Vietnam is a popular tourist destination which recorded 18 million tourist arrivals in 2019, while the industry almost totally collapsed after the outbreak of the COVID-19 pandemic. But it did not have much impact on foreign exchange earnings of Vietnam as it was based much more on export growth than on tourism, which is a highly volatile industry.