Inflation and Interest rates in Srilanka

In recent times we saw a huge increase in interest rates on fixed deposit rates and loans. Did you ever think about why it happened?

Well if your question is this then read this article to find out the answer. For better understanding let’s divide the topic into some subtopics,

1. The Economy
2. Interest rates

Economy in Crisis

We all know Sri Lanka is going through an economic crisis this year. This economic crisis leads the government not to balance imports and exports and we ran out of forex reserves.

It leads us to not import our necessary goods and services. But we all know the population is the same. Now for the same population, we have fewer goods and services. So people have to pay more than the actual price to acquire the goods and services.

In other words, This leads to a demand increase than a supply.

As prices increased government has to do something to overcome the problem. So they have to print more money and float it around for emergency solutions. But this creates inflation. Due to inflation, prices tend to go up. Demand increase. And this loop repeats.

To overcome this what can we do? Another effective solution leads to our next topic interest rates.

Interest rates in Srilanka

What do interest rates have to do with inflation? Let’s see we all know the economy is dropping because the demand is higher than the supply.

We can’t increase the supply now. Because we don’t have a forex reserve and importing goods can be very challenging. So the only way is to decrease the demand.

But how? Government can’t simply say people to don’t spend money. So only way to stop public spending is by locking public money.

Let’s see how this going to work, The first government implemented laws to increase the interest rates for investments and loans.

This leads to two outcomes,

1. People who have money in their savings accounts tend to put the money into a fixed deposit for a specific period of maturity time.
2. Most people get loans like credit cards/ homes/ cars to fulfil their needs. Now the loan interest rates increased. So people are less like to borrow money from banks and spend on things due to high-interest rates.

See what happens now, a lot of money will be deposited into banks and there will be less money given out. So people don’t have a high number of liquid funds to spend vastly. So people will buy less. This decrease the demand.

We can’t say demand and supply will be balanced. But we can decrease the demand percentage a lot.

And on the other hand, the government will give securities like Treasury bills and Treasury bonds to get the money from the primary dealer(Mostly banks). And use that money for development purposes instead of printing more money.

The problem with Intrest Rates

Now you may say this seems a good idea. Then why can’t we follow this and make things back to normal?

We can’t simply achieve that because let’s say you invested 100$ into a Fixed deposit or Treasury bill for one year with a 20% interest rate.

You can’t access your fund for only one year. At the end of the year, the government need to provide 120$. So from where did that 20$ come?

That 20$ generated, the government has to complete its correct planned development process and make 30$ from your 100$. And pay you back 20$ and government keep 10$ for its next developments.

However a normal investor can go to the bank and invest his/her money, but how government can increase its money? It’s through Foreign investments, Export, Tourism, Long term asset projects and much more.

If government achieve those things as planned, then everything would be fine. we will start to recover back on track.

In the worst case, If things don’t go as planned then the government can’t increase its revenue.

Let’s say the government only earned 10$ from your 100$ investment. To pay you back 20$ it has to print 10$. As I said earlier if the government prints unnecessarily, it increases inflation much more. And we will move on the worst track very quickly.

Interest rates not only decide inflation and the economy. There are much more things that affect inflation and the economy. But in this article let’s discussed the relationship between interest and inflation.

What is your role in Inflation?

So in this economic crisis/recession time, you have to be very aware of the financial markets and you have to control your spending habits.

Because you have to face the hard times of your excessive spending.Instead of spending your money in a recession time try to invest and grow the money.

Because a recession is a good opportunity for investing in short-term markets like Government securities, Fixed deposits and Resources like Commodities, real estate or lands.

However, investing in the stock market can be a little risky because the market can go down further based on investors’ sentiments.

But getting into the stock market as soon as possible at the end of the recession may be one of the wise investment decisions which will give a higher Return on Investment later. But in a peak recession time, it’s better to invest in short time investment schemes.

To know more about Government securities like treasury bills and bonds check the CBSL website

To Track how the stock market performs visit the CSE website

To invest in mutual funds, Check this article. But be sure to choose risk-free high-yield funds or income funds. Not long terms unit investments.