ECONOMYNEXT – Sri Lanka’s improvements in fiscal policy have not been shown in exchange and interest rates, although inflation management is good, Finance Minister Ravi Karunanayake said.
In 2016, Sri Lanka upped value taxes and also improved tax administration raising more taxes from the people to meet salary and subsidy bills that jumped in 2015.
Sri Lanka’s rupee has fallen ever since the Central Bank was created in 1951, as it tried to control both the exchange and interest rates by operating a so-called soft-peg, which cannot be done in the real world.
In order to keep the exchange rate steady or fixed, interest rates have to float depending on credit demand, though exchange controls can bring temporary relief at tremendous costs to economic freedoms and investor confidence.
China’s Renminbi is the latest and most dramatic example of the phenomenon, which is known as the ‘impossible trinity’ of monetary policy objectives.
After losing hundreds of billions of dollars of forex reserves and starting a longer term liquidity facility which worsened the problem and the Yuan falling steadily against the dollar, the People’s Bank of China has belatedly started to raise interest rates.
Rates also have to move up when the anchor currency central bank – in Sri Lanka’s case the US dollar – raises their own policy rates.
A pegged central bank operates a so-called ‘external anchor’ for inflation, and domestic inflation will be low as long as not much money is printed.
Though people paid more taxes, on January 02, tens of billions of rupees were printed as the Treasury repaid part of a maturing bond with central bank credit, flooding money markets with newly created rupees and making exchange rate management and inflation difficult.
Analysts have called for an overhaul of the Central Bank Act to block the ability of the Treasury to force the central bank to print money and make policy independent.
Currency weakness translates into domestic inflation quickly through the traded goods sector (exported and imported goods) and slowly through the non-traded areas as salaries, rents and school fees adjust as much as a year or more after the collapse.
Karunanayake is a known backer of a strong rupee.
"If you look at inflation tendencies, it had been good – management is good," he said.
"But from an interest perspective, from the rupee stabilization process it is certainly requires more human, more professional, more Sri Lankan oriented approach.
"The Governor has realized the political sensitivity and we basically are talking the same language now. You will see a tremendous change that will take place."
There has been concern that the Finance Ministry is trying to interfere in the Central Bank and economists and analysts have asked Central Bank Governor Indrajit Coomaraswamy, a much respected economist to conduct policy independently.
He denied that the government was trying to interfere in monetary policy and said there was a ‘harmonious relationship’ with the new Governor.
He said during the last administration the central bank overstepped its bounds and ventured into areas that it was not expected to do and became ‘politicized’. (Colombo/Feb17/2017)