ECONOMYNEXT- Sri Lanka’s central bank is resolved to maintain ‘relative monetary stability’ and will be vigilant about pressures from “extraordinary levels of policy accommodation” Central Bank Governor W D Lakshman has said.
“The central bank is resolved to be vigilant about maintaining conditions of relative monetary stability,” Governor Lakshman told reporters after keeping rates unchanged in an April monetary policy review.
“Demand side pressures could emerge as the economy begins to record above trend growth, supported by the extraordinary levels of policy accommodation, hence the need to be watchful.”
Sri Lanka has been printing unprecedented levels of money 2020 after tax cut in December 2019 generated a large hole in the budget.
Sri Lanka has printed close to 900 billion rupees in the past year to target overnight rates and also the yield curve and ran a 2.3 billion dollar balance of payments deficit in 2020 alone, earning two downgrades in the process.
However the central bank also printed money in 2018 despite tax hikes to lower a deficit, in a bid to close an ‘output gap’ and de-stabilized the external sector, triggering a currency crises which led to a consumption collapse and lower growth while raising inflation.
Sri Lanka’s central bank however has no growth mandate, but is only charged with maintaining economic and price stability to give a stable foundation for economic agents to generate growth instead of creating external instability and forex shortages by printing money.
Central bank watchers have traced the ending of prudent policy in the current monetary crisis to around August, 2019.
Active targeting of longer term yields also began before 2020 with the central bank jettisoning a previous ‘bills only’ policy.
After March 2020 the central bank had to accommodate an ‘internal drain’ or sudden demand for cash which does not create currency pressure.
The central bank arranged for a debt moratorium to help Covid-19 hit business and cut reserve ratios. Smaller reserve ratios improve the efficiency of the banking system.
However the central bank also let the exchange rate go under a non-credible ‘flexible exchange rate’ arrangement, driving panicking market participants and triggering downgrades in 2018 and 2020.
The policy is in sharp contrast to countries like Bangladesh and Vietnam, which maintained stable conditions, letting short term rates move up, and allowing foreign investors to return later in droves.
The rupee has fallen from around 131 to 202 so far under ‘flexible inflation targeting’ with a ‘flexible exchange rate’ since 2015.
Governor Lakshman however defended the central bank’s policy saying it had helped boost economic activity.
“As you are aware the central bank is on a monetary easing cycle for almost two years by now,” Governor Lakshman said.
“The subdued growth prevailed in 2019 was exacerbated by the outbreak of the pandemic in 2020.”
“The latter episode warranted monetary easing on an unprecedented scale alongside fiscal policy support.
“Such interventions by the central bank by measures such as policy rate reductions and large liquidity injections have helped many businesses and individuals to avoid severe hardships they would have otherwise been compelled to experience if left to themselves in the market under the most trying conditions that prevailed.”
“We are beginning to see the impact of these bold policy measures in the sharp turnaround of economic activity.
“Favourable developments in employment and income conditions of people improving credit conditions in helping economic revival and faster than expected rebound in a number of high frequency economic conditions.”
He said though negative 3.6 percent growth in 2020 was less bad than originally expected and early indications show a pick-up in activity.
“Why do you make such an assumption?” when asked whether loose monetary policy would now end.
“We only said we are watchful.”
The central and government remained “committed to maintaining the country’s external stability,” Governor Lakshman said.
Real sector activities and non-debt creating inflows were promoted.
Non-debt creating inflows, commodity exports, services, services exports including tourism, overseas worker remittances, foreign direct investments, foreign portfolio inflows, assisted by restrained levels of imports were key facets of a new approach to the external sector stability, he said. (Colombo/Apr14/2021)