Sri Lanka may be close to the top of rate cycle: CB Governor

ECONOMYNEXT – Sri Lanka may be close to the top of the rate cycle but government spending and inflation direction in the coming months will be key determinants of policy, Central Bank Governor Indrajit Coomaraswamy said.

"My gut reaction is that we are close to the top of the interest rate cycle," Governor Coomaraswamy told reporters.

"But there are important qualifications."

If there is a ‘significant fiscal slippage’ the central bank will have to respond with monetary policy.

And if headline inflation goes up due to supply side effects, there will have to be a monetary policy response to avoid secondary effects through wages for example, he said.

Inflation may spike in the months ahead, but fall back to the lower side of the 4-5 percent target in the first quarter of 2018, Coomaraswamy said.

Fiscal developments have been positive with government keeping to targets and making monetary policy easier, he said.

Coomaraswamy said he always complained that budget deficits was the key trigger of economic instability of Sri Lanka but from 2016, fiscal consolidation has been on the corrective path, though there may debate about individual spending decisions.

At the moment state enterprises were among borrowers.

Analysts say Sri Lanka’s credit bubble seems to be abating but it is right to be vigilant about persistent rises in inflation, whether they seem on the surface to be ‘supply’ related or otherwise.





Sri Lanka currently has a flood, but with credit moderating, and the central bank sterilizing forex purchases there is less inflationary pressure, though currency depreciation is continuing to push up prices and destroy real wealth.

While temporary supply shocks can happen, where a price of one or more goods go up, it does not necessarily make all prices in the economy to go up over any significant period. In general, infltion occures when a central bank accommodates a supply shock with monetary loosening.

If supply side or cost-push inflation in general was true, it should have happened before the 21st century also, when there was no fiat money, no US Fed and the Bank of England was private.

Supply side inflation is a type of excuse that became popular as part of the post-second World War neo-Mercantilist cost-push inflation myth.

As inflation around the world ratcheted up after World War II with the failed Bretton Woods soft-peg system of deprecating currencies and later fully fiat money, all kinds of excuses were given for inflation, including droughts, floods, wage-spiral inflation, economic growth, oil shocks and laughably even interest rate hikes.

Any excuse for inflation sufficed critics say, as long the reason was not monetary (related to money and credit including currency depreciation).

Among developed nations, Germany stood out as the sole exception and later Japan, which maintained tight monetary policy which resulted in strong exchange rates and low inflation. They were also export powerhouses. (Colombo/July03/2017)

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