Sri Lanka keeps rates unchanged amid rocketing credit, currency pressure
COLOMBO (EconomyNext) – Sri Lanka’s Central Bank said it would keep policy interest rates unchanged as private credit hit new highs, consumer prices rose and the rupee came under pressure, and the state cut taxes and raised public sector salaries.
The Central Bank said private credit growth hit a historic high of 76.5 billion rupees in December 2014.
"With low nominal interest rates and improving business confidence, it is expected that credit extended to the private sector would grow at a healthy pace in 2015," the Central Bank said in its February monetary policy statement.
Consumer prices rose to 3.2 percent during the 12-months to January 2015 from 2.1 percent in December 2014 which was "attributed to higher food prices."
The monetary authority said cuts in fuel prices and taxes of essential consumer items would result "considerable downward shift in inflation in the period ahead."
However other analysts say though indices can go down, ‘inflation’ which is monetary in nature cannot be influenced by cutting taxes and reduced surpluses at state enterprises would put further pressure on the credit system and a consumption boom would push demand up.
This will initially be seen in the form of higher imports and pressure on the exchange rate. But the index could move up later with non-traded items also moving up and a fall in the exchange rate eventually hitting traded goods as well.
So far this year the rupee has been allowed to fall 1.4 percent against the US dollar.
The administration also raised public sector salaries and subsidies along with the tax and fuel cuts, which has generated structural deterioration in state finances and consumption patterns.
To curb consumption and help banks raise more resources to fund private as well as state credit requirements in the face or lower surpluses or repayments of older loans by energy enterprises, market rates have to move up.
The Central Bank said policy rates would be kept at 6.5 percent to deposit excess cash at the Central Bank and 8.0 percent to inject new money.
But due to restriction in accessing the deposit window, overnight market rates usually fall below that making the 6.5 percent rate irrelevant on most days. The restriction would also remain in place.
Analysts say the sale of a sovereign bond can bring temporary relief to interest rates and credit system but will not address the underlying shocks to the monetary system from a pick-up in credit or any change in consumption patterns.
A pick up in credit and consumption can also help boost state revenues, and keep the economy in balance, provided the interest rate is not manipulated.
Sri Lanka has also been helped by benign external conditions with commodity prices easing as the US Fed ended deadly ‘quantity easing’.