Sri Lanka inflation picks up in 2019 as liquidity shortages end

ECONOMYNEXT – Sri Lanka’s inflation in the 12-months to June 2019 fell to 3.8 percent from 5.0 percent in May, but the consumer price index continued to climb steadily as liquidity shortages ended.

The Colombo Consumer Price Index rose 0.9 percent in the 30 days in June to 130.2 points. In May the index climbed 1.6 percent after rising 0.3 percent in April.

Sri Lanka’s currency collapsed in 2018 as the central bank printed money to cut rates in April 2018 claiming inflation and growth was low, despite having a pegged exchange rate.

The rupee collapsed from 153 to 182 to the US dollar during 2018 but liquidity shortages and a credit collapse kept prices down. Better harvests had also kept agricultural prices low.

Monetary instability ended in the first quarter of 2019. Analysts had warned that the price structure of the country had changed and inflation will tend to pick up after liquidity shortages end.

Though costs of firms had gone up, most firms were reluctant to raise prices due to poor customer demand and arrears from buyers.

Liquidity shortages prevent 1980s-style 20 percent plus inflation as the rupee depreciates and allow prices to stabilize if the currency bounces back, analysts say.

In the six months to June the Colombo Consumer Price Index had already risen 3.0 percent, from 126.3 points in December 2018 to 130.2 in June, compared to only 2.8 for the whole of 2019.

Stock prices have already started to climb rapidly, not just due to the end of liquidity shortages but also due to artificially low deposit rates from price controls, analysts say.

"Usually mal-investments are driven by central bank money printing from the credit side," explains EN’s economic columnist Bellwether.

"But when deposit rates are repressed by the state mandate, depositors themselves will see no point in having money in banks and asset prices can inflate even if there is not much bank credit.

"The effect will be greater if inflation is also set to rise."

However many companies in Sri Lanka have low valuations, and the economy is set to recover after monetary instability ended in early 2019.

Other than mandated deposit rate cuts, which can fire speculative activity by the rich, while harming poor people with bank deposits, monetary policy had been prudent so far in 2019, analysts say. 

However over the last two weeks the cental bank had allowed excess liquidity from the peg to build up to about 46 billion rupees, with no material permanent mopping up by outright sales of sterilization securities.

Sri Lanka has a soft-peg where excess liquidity builds up from a strong-side convertibility undertaking without any ‘printing’ of money. Analysts advocate steady permanent mopping up to keep excess liquidity around 20 billion rupees, because a ceiling policy rate makes it impossible to enforce a weak-side convertibility undertaking.

Any liqudity shortages which will strenghten the currency or put breaks on inflation is automatically filled by printing money to enforce a celing policy rate (sterilized forex sales). (Colombo/July26/2019)

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