When the State budget deficits are financed by the money printing machine
By F Barthassat
On August 15th this year, Burma’s mili
tary regime, the State Peace and De
velopment Council (SPDC), increased fuel prices massively without prior warning shocking the people of Burma. The price of compressed natural gas went up by 500 percent while diesel and petrol prices doubled.1 This was not the first time the people had experienced such hikes. In May 2006 the price of electricity increased ten times2 and in October 2005 the SPDC dropped certain subsidies on fuel, which led its price to rise nine fold.3
The hikes in state controlled prices are hitting the poorest part of the population hardest who are already facing very difficult living conditions. After the latest increase in fuel prices, bus and taxi fares in Rangoon and Mandalay doubled4 and a lot of people simply could not afford them anymore and had to walk.5 With rising transportation costs, commodity prices increased as well. Prior to the latest price increases people were already facing economic hardships. In May 2006, a single mother working in the private sector reported that her daily salary was 1300 Kyat (US $1). With that she was able to buy a small bag of rice for 500 Kyat and pay 400 Kyat for the bus to go between her home and her job. Afterwards she only had 400 Kyat left, to cover her family’s other basic expenses.6
Another example of an arbitrary measure with consequences on the national economy was the decision by the SPDC in late March 2006 to raise the salaries of approximately 1 million civil servants between 500 and 1200 percent by April 1st 2006.7 The reasons why the military junta in Burma took such drastic decisions to raise prices and salaries are diverse and will not be explained here. However they draw the attention to a problem in Burma’s economy, which is the high inflation rate (see Box). Price and salary hikes of these proportions have a huge impact on the general price level. This can be seen if we look closer at the example of the salary increases in April 2006.
The radical salary increase affected the inflation rate two fold. Firstly, due to the wage-price spiral, an economic rule, if the salaries increase, prices will also rise. Similarly, if prices increase, people need more salary from their employers. Also, if salaries increase in one sector, employees of other sectors will reqire higher wages as well. All these factors further contribute to the wage-price spiral. The wage-price spiral phenomenon could be observed after the announcement of the salary increase by the SPDC. One of the immediate consequences was that commodity prices on the local markets rose. Economists estimated that in the 6 weeks following the announcement of the salary increase, prices of commodities had risen at least by 20 percent on average.8
Secondly the way the salary increase was financed affected the inflation rate. Salary increases in the public sector of well functioning economies are normally financed by the ordinary government budget, meaning the taxpayer is paying for it. In Burma however the military regime faces problems in collecting regular taxes and even if this revenue system functioned well, they would still face problems to find the money to finance such a big increase.
Since it is doubtful that the SPDC had enough money to finance the salary hike, it would have to borrow money from somewhere. One possibility would have been to borrow it from commercial banks, another to issue government bonds and sell them to the public (see box). However, as the salary increase did not represent a sustainable investment for Burma’s economy, it would have been difficult to find any bank that would have given credit for that or persuade people to buy the bonds.
...only about 40 per cent of the junta's spending was covered by ordinary and legal tax incomes...
Given the unlikeness of the SPDC receiving a loan through the public money market, the only possibility left was to borrow money from the Central Bank of Myanmar (see box for the role of Central Banks). By asking them for a loan, it means nothing else than asking the Central Bank to print more money. The SPDC had often used this method in the past to finance expenditures. Printing more money to cover state expenditures means boosting inflation rates and devaluating the national currency.
But why does inflation go up when the SPDC tells the Central Bank of Myanmar to print more money? Printing money to finance the increase in state expenditure means that more money is supplied to the economic system in Burma. Thus, the quantity of money in the country increases but the amount of goods (for example rice) remains the same. Since the amount of goods doesn’t change, their value stays the same. However the value of the money decreases, because there is more money available.
At the end of March 2006, after the announcement of the salary increase, the value national currency on the black market decreased immediately and hit an all-time low with a rate of 1450 Kyat for 1 US$. Meanwhile the financial authorities maintained the official exchange rate (official value) unchanged at around 6 Kyat for 1 US$.9
Burma’s reliance on loans from the Central Bank to cover government spending has been the main reason for their double-digit inflation rate over the last few years. Burma Economic Watch, a University Institute based in Australia, estimates that for the fiscal year 2004/2005 only about 40 percent of the junta’s spending was covered by ordinary and legal tax incomes. The remaining 60 percent were covered by money lent from the Central Bank,10 This means that the SPDC is spending two and a half times more than its ordinary revenue and that huge government deficit is covered simply by printing more money.
The consequences of this practise can be seen when looking at Burma’s inflation rates. The Economist Intelligent Unit (EIU) estimates the inflation rate for the past twelve months (June 2006 – July 2007) to be about 30 percent, and outside the former capital it might even be higher.11 The official year by year inflation rates released by the SPDC for the period 2001 to 2005 vary between 3.8 (2004) and 58.1 percent (2002).12 However the official figures only seldom match the reality in the country. Economic experts like Sean Turnell from Burma Economic Watch qualify them as “notoriously unreliable” or even “deliberately misstated”.13
To encourage investment and ease generally economic activity in Burma, it would be essential to stabilise the inflation rates at a low level. The first step to this would be that the military regime stops borrowing money from the Central Bank of Myanmar to cover the huge deficits it produces. In order to do that the SPDC needs to reduce its budget deficit and to cover it through the ordinary money market.
State deficits are usually reduced via two ways. One is to increase ordinary revenues and the other to cut spending. To increase revenues, it would be necessary that the central government tries to increase effectiveness and compliance of the ordinary tax collect system. This would imply stopping the army raising arbitrary taxes on the local population. Spending could be reduced for example by prioritising investments for infrastructure project enhancing economic development rather than projects serving only military purposes.
By following certain basic and well proved economic rules would mean a change to some incrusted habits within the economic policies of the SPDC. However, it would be in their best interest to do so. If economic activity is allowed to develop properly and people can earn a minimum living, it also leads to a stronger internal position of the SPDC and money spend on security could be saved. Similarly, ruling a prosperous country also increases the revenue for their leaders. China is currently an example that authoritarian rule and economic development don’t exclude each other, at least not in the short term. We can only hope that people in the military elite of Burma will realize that opportunity in the near future so that the population will be freed at least from one heavy burden in their country.
Terminology
Inflation is an economic term that describes the phenomenon of persistent rise of the general price level. Inflation exists in every country. In good functioning economies it is at a level below 5%. If the inflation rate is low it allows a good functioning of the economic system. When inflation rates are very high, the money looses its value very fast and prices and wages rise constantly, making it more difficult for people to run economic activities.
Government Bonds are issued when governments want to raise money for example for an infrastructure project. They borrow money from the public and in exchange issue them an official document that is called a bond. The public receives a regular interest rate on its loan and this makes it an attractive investment. However, the public will only be keen on buying bonds, if they are confident that they will receives their money back. The more the people trust the government, the more they will be willing to buy its bonds.
A Central Bank is the national monetary authority of a country. The primary responsibility of a Central Bank is to maintain the stability of the national currency and to control the money supply to the national economy. This responsibility gives the Central Bank the authority to issue and recall the banknotes of the national currency. Consequently most economists believe that the Central Bank has to have a minimum degree of independence from the government of a state. Otherwise there is a risk that the Central Bank will follow the interest of the government in power, rather than what is in the best interest of the national economy. This is actually what is happening in Burma at the moment.
Endnotes:
Bangkok Post, “Soaring petrol costs deepen woes”, August 20th 2007
Agence France Presse, “Myanmar hikes electricity rates 10-fold”, May 23rd, 2006
Associated Press, “Prices for consumer goods and services jump after Myanmar fuel price hike”, October 21st, 2005.
Bangkok Post, op.cit.
APPPB Update, “88 Gen Students led Peaceful Protest over Fuel Price Hike in Burma Today”, August 19th, 2007
Agence France Presse, “Myanmar’s inflation soars after military raises wages”,
May 15th, 2006.
Sein Htay, “Burma Economic Review 2005
– 2006”, The Burma Fund (NCGUB), June 2007, p. 7.
Agence France Presse, op.cit.
Sein Htay, op.cit. p. 58.
Sean Turnell, “Burma’s Economic Prospects
– Testimony before the Senate Foreign Relations Subcomittee on East Asian and Pacific Affairs, March 29th, 2006”, Burma Economic Watch, March 2006, p. 5.
Sean Turnell in an email to Burma Issues on August 2nd 2007.
Central Statistical Organisation, http://www.csostat.gov.mm/Sdetails.asp?ID=003&Desc=Prices [Aug 29 2007].
Sean Turnell, op.cit. p. 3.
To go to the other articles published in the August 2007 BI Newsletter click on the links below:
...only about 40 per cent of the junta's spending was covered by ordinary and legal tax incomes...
