Sri Lanka inflation nears 4.9-pct IMF ceiling ahead of June deadline

ECONOMYNEXT – Sri Lanka’s central bank has generated 4.8 percent inflation up to May 2016, a tad short of the 4.9 percent ceiling set for June by an International Monetary Fund deal agreed with the authorities.

Under a ‘monetary policy consultation clause’ set in a 3-year Extended Fund Facility, consumer price inflation has been made a ‘performance criteria’ for the first time instead of a simpler reserve money target or the domestic assets ceiling of the central bank.

If inflation exceeds 4.9 percent in June, the central bank has to "complete a consultation with IMF staff on the reasons for the deviation and the proposed policy response."

If the central bank inflates the economy 6.4 percent by June, 7.5 percent by September of 8.2 percent by December the IMF program will be suspended and a consultation with the Fund’s executive board will follow.

The IMF Executive Board which would focus on the stance of monetary policy and whether the Fund-supported program remains on track; the reasons for the deviation; and on proposed policy response.

The monetary policy consultation clause is a recent experiment of the IMF which is used in countries where the central bank generates lower levels of inflation.

Sri Lanka’s central bank has generated lower levels of inflation since 2007, when it started to operate a tighter peg with the US dollar. Spikes in inflation came when the currency collapsed after it printed large volume of money in a short time.

When a peg is defended, money printed by the acquisition of domestic assets is mopped up in the forex markets, automatically tightening the system and leading to a credit collapse if intervention and liquidity injections (sterilized forex sales) continue for a long time.

Sri Lanka has had much higher levels of inflation when it operated a ‘crawling peg’ in the 1980s and early 1990s. However the rupee is still on a long term downward path, unlike other Asian countries with more successful central banks. (Colombo/June20/2016)

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