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Further monetary loosening in Sri Lanka is not necessary: HSBC

COLOMBO (EconomyNext) – Sri Lanka does not need further monetary loosening since lending rates are at record lows, with higher state spending expected, though inflation is low, HSBC has said.

"In our view, further monetary policy easing is not needed since market lending rates have already declined to record lows and private sector credit growth is witnessing a nascent recovery," HSBC said in a research note.

"We expect the central bank to remain on hold for an extended period as additional government spending expected in the mini budget on January 29th and the boost to purchasing power from falling inflation spurs credit growth."

The newly appointed Governor Arjuna Mahendran had held rates as expected but close attention should be paid to his future statements, the note said.

HSBC said with growth "close to potential" and inflation remaining low, there was "room" to cut rates, but it expected the Central Bank to "to stay on hold to observe the full pass through of past monetary policy actions before making the next move."

"While today’s statement indicates that he broadly agrees with the central bank’s existing assessment of the economy, which should imply an extended pause, we still believe it is necessary to pay close attention to his statements in the future," HSBC said.

The note said additional state spending in a budget revision to presented on January 29 was likely to lift domestic demand. But policy uncertainty from the regime change could delay investment, which may reduce growth.

"We believe the caution exercised by the central bank is good for macro-economic stability and positive for investor sentiment on the island," HSBC said.

"Apart from macro-economic stability, reform steps that deepen the engagement of the private sector in the economy is necessary to maintain high growth momentum on a sustainable basis."

"We expect the central bank to remain on hold for the foreseeable future."

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Sri Lanka’s central bank has a strong record in creating high inflation and balance of payments troubles by delaying rate increases, critics say.

Though the central bank became better at controlling inflation after 1995, it has continued to precipitate balance of payments trouble by delaying rate increases when there are spurts of state spending financed by bank borrowings.

Very often the trigger is a sudden rise in energy subsidies.

Though international commodity prices are low with better US monetary policy, keeping inflation low in the dollar-pegged country, rapid credit growth of both state and private sector seen in the last quarter if continued can spell trouble, analysts say.

Governor Mahendran told EconomyNext, that he expected foreign reserves to pick up now that election uncertainty was over and external demand would also support growth.