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Sri Lanka CB holds rates; says easy money, tax cuts boosting imports; state credit up

ECONOMYNEXT – Sri Lanka’s has held policy steady saying easy money and tax cuts are boosting imports and also noted that rising credit to state and state owned enterprises are expanding money supply.

Inflation was 0.2 percent in the 12-months to May and the Central Bank is expecting year end inflation to be below 4.0 percent.

"In this background, the Monetary Board was of the view that the current monetary policy stance is appropriate," the June monetary policy review said.

The Central Bank said it was keeping policy rates at 6.00 percent to withdraw excess liquidity and 7.50 percent to inject liquidity.

Analysts had pointed out that more than just the rates the actual monetary policy stance over the past few months was to release over 300 billion rupees in excess liquidity in to money markets in a ‘quantity easing’ exercise.

When excess liquidity is consumed by the credit system imports are generated over and above inflows, generating currency pressure, in the same was as balance of payments pressure develops when Treasury bills are bought by the Central Bank to print money.

In April rates were also cut. Earlier in the year, fuel prices were slashed, increasing disposable incomes of people, allowing extra spending on non-oil imports while reducing the margins or generating actual losses at state energy utilities.

But rates were held down by releasing tens of billions or rupees in to interbank markets.

A tax cut and loose money favoured increased imports of cars, the Central Bank said.

"Meanwhile, cross currency movements, tax adjustments favouring the importation of lower engine capacity motor vehicles and eased monetary conditions resulted in increased imports in April 2015," the Central Bank said.

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Analysts however had warned that loose fiscal policy, financed by credit was boosting not just cars but all types of consumption.

Though Sri Lanka cut taxes in cars in late January, imports were booming from before December. There was also a flood of motorcycles from discriminatory privileges given to state workers that are not available to the man on the street.

Broad money grew 13.9 percent in April and private credit was up 15.2 percent with around 25 billion rupees of credit being given every month.

"Meanwhile, the increase in net credit to the government and State Owned Enterprises (SOEs) by the banking sector also contributed to the monetary expansion," the Central Bank said.

Update II