Sri Lanka should be ready to tighten monetary policy: IMF

ECONOMYNEXT – Sri Lanka should be ready to tighten monetary policy if inflation and credit growth remains high, the International Monetary Fund said, welcoming a recent rate hike, though the release of the next tranche its program awaits tax legislation.

Under a deal with the IMF, Sri Lanka’s central bank’s discretion to generate inflation and balance of payments trouble has been reduced, with inflation ceilings and a foreign reserve target, both of which make it more difficult to print money and keep rates low.

"“The mission welcomes the Central Bank of Sri Lanka’s (CBSL) move to preemptively raise policy rates to maintain inflation within its target band," the IMF mission chief Jaewoo Lee said in a statement.

"The CBSL should remain vigilant in monitoring inflation pressures and stand ready to tighten further should inflation or credit growth continue to rise."

With the central bank raising rates, and also keeping money markets short of cash after intervening, instead of printing money to flush the system with excess liquidity, pressure on the rupee has reduced compared to last year.

Under the IMF program Sri Lanka’s central bank is committed to buy foreign reserves, which will can prevent the currency appreciating despite tighter policy. To buy foreign reserves however, domestic credit has to be curbed.

The release of a second tranche under the IMF program could be delayed until the administration passes tax legislation.

An attempt to collect taxes from the people by minister’s prerogative, despite the existence of a parliament, was foiled this year after activists went to court.
 
"In light of easing external pressures, the mission encourages the CBSL to continue its effort to rebuild international reserves and maintain exchange rate flexibility to further develop the foreign exchange market," Lee said.

"In this regard, the mission and the authorities discussed plans for a transition to flexible inflation targeting as the monetary policy framework, possibly supported by IMF technical assistance."

Flexible inflation targeting may involve giving more discretion to a central bank than the original inflation targeting developed by the Reserve Bank of New Zealand.

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For proper inflation target to work however, the exchange rate has to float and the central bank cannot buy dollars build reserves (and alter the money supply or sterilized to prevent it) or sell dollars to maintain the exchange rate. (Colombo/Sept26/2016)

 

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