ECONOMYNEXT – Sri Lanka will maintain its current policy corridor of 5.50 percent to inject overnight money while a worsening third Coronavirus wave will hurt economic output, requiring more fiscal and monetary stimulus’ the central bank said.
Sri Lanka is injecting overnight money into banks which are short at 5.50 percent and is also injecting permanent or longer term cash at a 5.18 percent ceiling rate set for Treasuries auctions, which is triggering a balance of payments troubles.
“The Sri Lankan economy, which rebounded notably during the second half of 2020 and early 2021 as per available indicators, is experiencing renewed disruptions due to the emergence of the third wave of the COVID-19 pandemic and related preventive measures, including isolations,” the central bank said in its May monetary policy review.
“While its adverse effects on economic activity are expected to be lesser than during the first two waves due to the selective nature of mobility restrictions and the ongoing vaccination drive, the third wave has once again highlighted the disruptive nature of the pandemic and the challenges faced in sustaining the economic recovery amidst the pandemic.
“It has also highlighted the need for continued fiscal and monetary support to place the recovery process on a firm footing.”
The call came as net credit to government from the credit system rose 54 percent and net foreign assets component was a negative 1,629 percent in the year to March 2021.
Covid lockdown in most countries lead to falls in consumption, credit and reduced currency pressure.
The central bank said inflation was low and expectations were “well anchored inflation” and the Monetary Board was “committed to maintaining the current accommodative monetary policy stance to support the sustained revival of the economy”.
The full statement is reproduced below:
The Central Bank of Sri Lanka continues its accommodative monetary policy stance to support the sustained recovery of the economy
The Monetary Board of the Central Bank of Sri Lanka, at its meeting held on 19 May 2021, decided to maintain the Standing Deposit Facility Rate (SDFR) and the Standing Lending Facility Rate (SLFR) of the Central Bank at their current levels of 4.50 per cent and 5.50 per cent, respectively.
The Board arrived at this decision after carefully considering the macroeconomic conditions and expected developments on the domestic and global fronts.
In the context of the prevailing low inflation environment and well anchored inflation expectations, and the renewed challenges posed by the third wave of the COVID-19 pandemic, the Board remains committed to maintaining the current accommodative monetary policy stance to support the sustained revival of the economy.
The third wave of the COVID-19 pandemic has disrupted the ongoing recovery of economic activity
The Sri Lankan economy, which rebounded notably during the second half of 2020 and early 2021 as per available indicators, is experiencing renewed disruptions due to the emergence of the third wave of the COVID-19 pandemic and related preventive measures, including isolations.
While its adverse effects on economic activity are expected to be lesser than during the first two waves due to the selective nature of mobility restrictions and the ongoing vaccination drive, the third wave has once again highlighted the disruptive nature of the pandemic and the challenges faced in sustaining the economic recovery amidst the pandemic.
It has also highlighted the need for continued fiscal and monetary support to place the recovery process on a firm footing.
The external sector remains resilient despite a multitude of challenges
The merchandise trade deficit widened in March 2021, driven by a higher increase in expenditure on imports than the increase in earnings from exports. Meanwhile, the notable increase in workers’ remittances continued during the period from January to April 2021, over the corresponding period of the previous year. However, the recent surge in the global spread of COVID-19, could affect the recovery of the tourism industry, while posing renewed challenges to the external sector.
The Sri Lankan rupee depreciated by 6.6 per cent against the US dollar thus far in 2021, and the continuation of the existing restrictions on non-essential imports and selected foreign exchange outflows is expected to help ease the pressure on the domestic foreign exchange market.
Meanwhile, the measures taken by the Government and the Central Bank helped secure foreign exchange inflows into the country, with additional standby arrangements to bolster confidence in the Sri Lankan economy. As at end April 2021, gross official reserves were estimated at US dollars 4.5 billion, equivalent to 3.2 months of imports. This does not include the bilateral currency swap facility with the People’s Bank of China (PBoC). 2
Prevailing historically low interest rates have resulted in an acceleration of private sector credit
Reflecting the gradual transmission of the monetary policy easing measures adopted by the Central Bank thus far, market interest rates have displayed a broadbased decline to their historic low levels.
The prevailing accommodative monetary policy stance and the high level of rupee liquidity maintained in the domestic market are aimed at supporting the economic recovery through the provision of affordable credit to productive sectors of the economy. Accordingly, credit extended to the private sector increased notably during the first quarter of 2021, with increased credit disbursements to all key sectors of the economy.
The introduction of priority sector lending targets for banks on lending to the micro, small and medium scale enterprises (MSME) sector will continue to provide further support for promoting credit to the needy sectors of the economy. Meanwhile, credit obtained by the public sector from the banking system continued to rise during the first quarter of 2021.
Yields on government securities also showed some increase, reflecting the impact of the increased financing requirement of the Government amidst the decline in revenue and the increase in expenditure, including pandemic related expenses. The expansion of domestic credit caused the growth of broad money (M2b) to remain elevated.
Inflation is expected to remain within 4-6 per cent range in the near to medium term, while any pressures over the medium term will be addressed with appropriate measures
Inflation remained subdued thus far in 2021, supported by well anchored inflation expectations and subdued aggregate demand conditions. While some inflationary pressures could emerge in the near term driven by supply-side disruptions due to the third wave of the pandemic as well as adverse weather conditions, inflation is expected to remain broadly within the desired target range of 4-6 per cent during the remainder of the year.
Although the effects of the fiscal and monetary stimulus measures are expected to exert some upward pressure on inflation over the medium term with the envisaged improvements in aggregate demand conditions, such pressures will be mitigated through timely measures by the Central Bank, thereby ensuring the maintenance of inflation in mid-single digit levels in the medium term, while facilitating the sustained and high economic growth in the period ahead.
Policy rates are maintained at current levels
In consideration of the current and expected macroeconomic developments highlighted above, the Monetary Board was of the view that the current accommodative monetary policy stance is appropriate. Accordingly, the Board decided to maintain the policy interest rates, i.e., Standing Deposit Facility Rate (SDFR) and the Standing Lending Facility Rate (SLFR) of the Central Bank, at their current levels of 4.50 per cent and 5.50 per cent, respectively.
The Central Bank will continue to monitor domestic and global macroeconomic and financial market developments and stand ready to take proactive measures to help the economy to sustain the growth trajectory, while maintaining inflation in the targeted 4-6 per cent range under the flexible inflation targeting framework