By Chandeepa Wettasinghe
A one-off effect of the Value Added Tax (VAT) increase on education spending was the main contributor to core inflation in Colombo this January, which should alleviate concerns on sustained high inflation, Central Bank Governor Dr. Indrajit Coomaraswamy said last week.
Private education and healthcare were taken out of the VAT exemption list by the recent revisions to the country’s tax structure by the coalition government in a bid to increase government revenue.
“If you look at inflation, headline inflation is still within the target band. Core inflation has gone up. It has gone up to 7.2 percent. If you look at the increase in core inflation that has taken place, almost 50 percent of it is explained by education,” he said.
Core inflation does not take into account goods and services that could cause inflation spikes, such as some food items, energy and transport.
Dr. Coomaraswamy noted that since most schools and education institutes levy fees in January, the effect of the VAT increase in education spending would only have occurred last month.
“That is what explains more than 50 percent of the increase in the core inflation rate,” he said, even though he asserted last year that the VAT increase would have a minimal impact on inflation. However, he also noted that this increase was a one-off effect.
The effect of VAT on education is unlikely to materialize heavily on national inflation figures—on which calculations began only in 2014—since in December, for which data is available on both national and Colombo indices, increases in education spending in Colombo had been 10 times the national figure, despite the Western Province weighing heavily on national indices.
Further, a majority of fee-paying schools and institutes are centered in Colombo, with some tertiary education institutes gaining traction in Kandy and Galle.
Meanwhile, Dr. Coomaraswamy also noted that the change of the base year of calculation, as well as the change in the composition of the inflation indices, where food items are now contributing 28 percent towards calculations from the earlier 41 percent, have also caused increases in inflation in January.
He added that supply side disruptions due to inclement weather conditions have also contributed towards inflation.
“It’s not demand side pressure that has pushed up inflation. As a result it is not appropriate to increase interest rates on the basis of the increase in core inflation,” he noted.
Headline inflation, which includes the total basket of goods, increased 5.5 percent year-on-year in January.
To remain qualified for a US$ 1.5 billion balance of payments relief package from the International Monetary Fund, the Central Bank is required to maintain year-on-year inflation below 8.1 percent by end-December 2017, with an increase above 6.6 percent requiring consultation.
The IMF has defined the centre-point for inflation at 5.1 percent for this year.