ECONOMYNEXT – Sri Lanka may not enact draft legislation to change the monetary law governing the central bank which seeks to establish ‘flexible’ inflation targeting, but the new administration is committed to price stability, a top official said.
“I do not think we would be keen to pass it,” Senior Economic Advisor to the Finance Minister and Prime Minister, Nivard Cabraal said.
“But we are committed to price stability.”
Inflation targeting was part of an overall goal of maintaining economic and price stability, he said, and not the only goal.
“Inflation is a key goal certainly, and we have done that even in the past,” Cabraal who was also a former central bank governor said.
Sri Lanka has been following a so-called flexible inflation targeting, a type of discretionary targeting of a high domestic anchor (consumer price index) as high as 8.0 percent, while also targeting an exchange rate (external anchor) to build up foreign reserves (injecting reserve money through dollar purchases), triggering dual anchor conflicts.
Under the ‘flexible exchange rate’ the rupee collapsed from 153 to 182 to the US dollar in 2018. The rupee was also depreciated in 2017 despite weak private credit.
Under a program with the International Monetary Fund, now in effect the inflation target ceiling (upper band) is 8.0 percent for March 2020, with an inner bank upper limit of 6.5 percent.
Analysts have raised concerns that the ‘flexible’ inflation targeting along with a ‘flexible exchange rate’ a highly unstable non-credible peg, did not eliminate the dual anchor conflicts that had triggered balance of payments trouble and IMF bailouts in the past.
The rupee collapsed in 2018, with the ‘flexible exchange rate’.
There had been warning that the domestic anchor was too high to prevent monetary instability.
Successful inflation targeting central banks have target of around 2 percent with a fully floating exchange rate (no reserve money is injected or taken away through foreign exchange operations to alter the monetary base).
Once an inflation targeting law is passed, a target is jointly set in consultation with the finance ministry.
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Analysts have called for genuine inflation targeting or a consistent peg with market determined short term rates, to avoid currency trouble and provide monetary stability with low interest rates.
The draft law also did not propose to eliminate a Treasury presence in the central bank, as originally expected. (Colombo/Dec04/2019)