ECONOMYNEXT – Sri Lanka’s central bank is expecting inflation to reduce to its target range of mid-single digits in 2018, with near term monetary policy to be data driven, Central Bank Governor Indrajit Coomaraswamy said, after generating over 7 percent inflation in 2017.
"By the end of the first quarter (of 2018) we will be within the target range of 4-6 percent," Coomaraswamy told reporters.
The central bank generated 7.1 percent inflation measured by a revised Colombo Consumer Price Index in 20187 which spiked to 7.8 percent in October, after generating 4.5 percent in 2016 and 4.6 percent in 2015, despite falling global commodity prices.
Global commodity prices have started to pick up in 2017.
The rupee has collapsed from around 131 to 153 to the US dollar during the last year three years due to massive money printing in 2015 and 2016 but falling commodity prices kept the prices of traded goods muted in the first two years.
Monetary policy is tighter now with higher interest rates and liquidity in money markets being generated from central bank forex purchases and being steadily withdrawn (sterilized), helping build up forex reserves.
The central bank kept its overnight policy rate at 7.25 percent to withdraw excess liquidity and 8.75 percent to inject cash (print money) at its December monetary policy meeting, while market rates fell amid slower credit.
With money markets having excess liquidity amid lower credit growth with a more controlled budget deficit, the central bank buying dollars generating liquidity, interbank rates are now near the lower policy corridor indicating that the active policy rate is 7.25 percent.
Data Driven Policy
Coomaraswamy said in 2018, the central bank will be data driven in its policy changes.
Coomaraswamy tightened policy after he was appointed, ending a balance of payments crisis and capital flight, and the credit system and economy is now stabilizing.
The central bank will watch wage pressure and inflationary expectations in making future monetary policy decisions, he said.
"In the coming months the monetary board will watch wage settlements," he said. "The other thing is inflation expectations."
Sri Lankan’s have been hit by high inflation and balance of payments crises ever since the money printing central bank was created in 1951 ending a currency board (hard peg) that kept the economy stable from 1885. Before that Sri Lanka had free banking.
Until 1977, the soft-peg which was de-stabilized with money printing was kept with draconian exchange and trade controls which put the economy in a strait jacket, driving unemployment to over 20 percent.
After 1978 a money-printing and currency depreciation strategy was followed giving rise to inflation over 20 percent in some years, and conditioning the population to expect high levels of inflation.
Compared to the central bank’s past performance in the 1980s even 7 percent inflation is a good outcome.
Coomaraswamy claimed that some of the inflation in 2017 was beyond the control of the central bank and with tighter monetary policy so-called core inflation which he claimed was within the control of the monetary authority – but which ordinary people do not feel – was now down.
That half or some other proportion of Sri Lanka’s inflation is due to cost-push or some other mysterious factor and only a portion is due to demand-pull is a favourite excuse given by Sri Lanka’s inflationist central bank for decades.
This time a hiked value added tax and drought was blamed for the central bank generating more inflation than it promised.
There is also no provision in central banking in the modern-era to reverse inflation created in excess of targets and missed targets are cumulative.
Before World War I under the gold linked standard, periods of credit growth and inflation was followed by periods of deflation. However during and after World War I, the Sterling went off the gold standard.
After World War II, the Bretton Woods system of soft-pegs – this time linked to the US dollar after the pound was displaced – generated large volumes of irreversible inflation. The soft-peg system collapsed in 1971-73 with a massive commodity shock, leading to completely fiat money.
In the period various so-called ‘cost-push’ fallacies were born to excuse inflationary central banking.
Higher inflation after World War II was justified by many fallacious claims, including the Phillips Curve, which went out of the window after monetary tightening in the Thatcher-Reagan era and later formal headline inflation targeting by New Zealand which put the brakes on fiat money central banks. (Colombo/Jan01/2018)