Sri Lanka growth to reach 5.0-pct in 2016, despite tighter policy: CB Governor

ECONOMYNEXT – Sri Lanka’s economic growth will pick up in the second half of 2016 to end the year between 5.0 to 5.3 percent, despite a slowdown to 2.6 percent in the second half and a rate hike in July, Central Bank Governor Indrajit Coomaraswamy said.

Growth in the second half may also be revised up later he said.

Growth Pick Up

A flood and drought however hit agriculture, leading to a contraction of 5.6 percent in the second quarter.

Credit demand from areas like construction is strong, with cement demand and electricity sales was also growing strongly, indicating strong economic activity, which made an upward revision likely, he said.

However in the way economic output is calculated, imported cement and higher levels of thermal power generated from foreign fuel is a negative number, which tends to reduce domestic value added.

There was also a ‘base effect’ which statistically dampened the second quarter growth number because the second quarter of last year showed 7.0 percent growth, Coomaraswamy said.

Last year, Sri Lanka’s Latin America style, central bank printed hundreds of billions of rupees to finance a budget deficit, lower interest rates and sterilize forex interventions, pushing demand to unsustainable levels, generating a balance of payments crisis.

BOP Deficit Driven Bubble

Economic activity and imports however can surge by a rundown of forex reserves and a balance of payments deficit.

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The Central Bank then raised the statutory reserve ratio – an archaic tool which simply makes the credit system inefficient and has been abandoned by central banks which generate low inflation – and also raised rates.

Coomaraswamy said the economy will grow despite the rate hike. Credit demand was still strong, and was running at 25 percent by July 2016.

Rate hikes do not necessarily slow growth immediately. The current credit cycle has been running from around August 2014, when credit which had turned negative after a 2011/2012 balance of payments crisis, ended.

Coomaraswamy said Sri Lanka had spurts of growth to 7 percent levels, which was accompanied by budget deficits, which was not sustainable and led to overheating.

Current Account Driven Growth

Sri Lanka needed to improve the policy environment, ease of doing business, to draw foreign direct investment and drive growth through a surplus current account, he said.

Budget deficits have to come down allowing stable macro-economic environment, he said.

Analysts say in 2015 there will not be a run-down of foreign reserves, but a slight rebuilding under an IMF program.

To re-build foreign reserves, domestic credit and economic activity has to slow, in contrast to a balance of payments driven activity that happens when a central bank prints large amounts of money.

Coomarswamy said in 2016, the balance of payments may end in a surplus.

However foreign capital which fled the country in 2016, has started to return to Sri Lanka’s bond markets. When the central bank prints money and generates pressure on the currency foreign capital flees. (Colombo/Sept28/2016) 
 

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