ECONOMYNEXT - The International Monetary Fund has recommended tight monetary policy as high inflation continues to dog Sri Lanka, though some analysts a depreciating currency will push prices up however tight monetary policy is.
"Inflation and credit growth remain on the high side," the IMF said Mitsuhiro Furusawa, Acting Chair and Deputy Managing Director, said after the lender approved a 251.4 million dollar tranche under its program.
"Maintaining a tightening bias for monetary policy is recommended until clear signs emerge that inflation pressures and credit expansion have subsided.
"Macroprudential tools should also be used to help rein in credit growth and head off systemic risks."
Sri Lanka's money printing central bank which operates an unstable soft -peg has de-stabilized the economy since 1951, critics say.
Until 1977 it operated a dollar soft-peg by printing money and draconian exchange controls, and after 1978 it printed money and let the exchange rate go (crawling peg), generating inflation close to 30 percent a year, when US inflation was also high.
In the 12-months to November 2017 Sri Lanka's central bank generated inflation of was 7.6 percent, higher than the price rises created by many Asian central banks despite policy rate at 7.25 percent, one of the highest in Asia and double digit market rates, amid currency depreciation.
The rupee has fallen from 149.8 to the US dollar in December 2016 to 153.76 in November 2017, according to official data.
Sri Lanka also does not market price energy, with shocks absorbed by the credit system, which are the monetarily accommodated.
As a result of contradictory monetary and exchange rate policies the country has run into frequent balance of payments crises, with deficit spending also made possible by monetary forbearance as well as fiscal dominance of monetary policy requiring IMF bailouts.
The IMF said tax increases were bringing revenue but state enterprises had to be fixed, since there was a lot of debt from past deficits.
“Sri Lanka’s performance under the Fund-supported program has remained broadly on track since the second review," Furusawa said.
"Macroeconomic and financial conditions have been stable, despite a series of weather-related supply shocks.
"The authorities remain committed to the economic reforms under the program and have undertaken measures to improve government revenue and accumulate international reserves.
"Going forward, it is important to build on the progress made and accelerate reforms to reduce fiscal and external vulnerabilities.
“Fiscal performance has been satisfactory and all targets until September were met. The new Inland Revenue Act will make the tax system more efficient and equitable, and generate resources for social and development programs.
"Nevertheless, Sri Lanka’s high debt burden, large gross financing needs, and weak financial performance of state-owned enterprises increases the importance of further fiscal consolidation.
"Timely progress in structural reforms, including tax administration and energy pricing, will support fiscal consolidation."
The IMF also asked for the exchange rate to be 'flexible'. Under the IMF program Sri Lanka has to collect foreign reserves, indicatng that the central bank is operating a de facto dollar peg.
“Along with efforts to deepen the foreign exchange market, it is important to further accumulate reserves and enhance exchange rate flexibility to reduce Sri Lanka’s external vulnerability," he said.
Sri Lanka's central bank is now buying dollars amid lower credit growth (compared to deposits), and mopping up rupees generated by selling down its Treasury bill stock (sterilized forex purchases), reversing the process of printing money that generated the BOP crisis in 2015 and 2016.
“Structural reforms are also needed to enhance competitiveness and promote inclusive growth, including measures to improve trade and investment regimes.”
Sri Lanka's 2018 budget has proposed trade and structural reforms including a key opening up of the shipping sector, but the finance ministry is facing opposition from entrenched domestic business interests who are also supported by sections of the coalition partner Sri Lanka Freedom Party.
(Colombo/Dec08/2017 - Update II)