Sri Lanka should raise rates, not give rate cut sugar to diabetic: ex-CB Deputy Governor

ECONOMYNEXT – Sri Lanka’s Central Bank should raise rates instead of injecting sugar to an already diabetic credit system which is burning up with high loan growth, former Deputy Governor W A Wijewardene has said.

Sri Lanka’s high credit growth and central bank financing of the budget deficit is hitting the balance of payments and undermining overall economic stability and confidence.

"It requires the bank to increase interest rates and not cut interest rates further in order to curtail the credit levels in the economy," Wijewardene wrote in his column in Sri Lanka’s Daily FT newspaper on November 02.

"This is a painful action but that is what the bank is expected to do in such a situation. To attain its objective, it has to get the full cooperation of the new Good-Governance Government.

"But reducing the interest rates at this juncture is similar to giving an additional sugar dose to a diabetic who already has high sugar levels in his blood."

He warned that a call by Sri Lanka’s Finance Minister Ravi Karunanayake in a Reuter’s report to cut rates by 100 to 200 basis points

"Such public announcements made by the minister also undermine the independence of the Central Bank and its position among global market participants," he pointed out.

Sri Lanka’s monetary policy has long suffered from fiscal dominance, and along with rural credit re-finance has been a key culprit responsible for high inflation and an ever-downward crawling ‘soft-dollar’ peg with the US dollar.

Wijewardene said he could understand the Finance Minister’s desire for growth, but long term growth cannot be achieved by loose monetary policy, as believed by Keynesians.

In small open-trading countries such actions quickly lead to balance of payments troubles, currency depreciation and high inflation.

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The Central Bank’s founder John Exter had cautioned against such moves when it was set up over 60 years ago, Wijewardene said.

"In a country like Ceylon, however, which is very dependent upon imports, in which half the productive resources are devoted to export, and which is chronically short of capital equipment, such policies would tend to raise domestic prices without producing an adequate response in domestic output," Exter had said in his policy report founding the bank.

"Instead, higher domestic income would stimulate the consumption of imported goods and precipitate serious balance of payments difficulties."

Wijewardene said narrow money made up of demand deposits and currency held by the public had gone p 20 percent, broad money 17 percent and private credit was rising 20 to 23 percent, while the budget deficit was widening.

Central Bank financing of the deficit (printing money was) 174 billion rupees.

The Central Bank sold down a part of its Treasury bill stock and sterilized a dollar inflow after selling a 300 million dollars in floating rates after financing the government for spending and debt repayments to the tune of over 200 billion rupees.

Wijewardene said the Central Bank should also be careful with the liquidity coming from the conversion of a 1.5 billion US dollar bond.

He said several analysts including the International Monetary Fund, the columnist Bellwether on EconomyNext.com, the Institute of Policy Studies had warned of the danger of low interest rates and balance of payments troubles.

Wijewardene said relying on a low inflation number when credit was growing fast was not prudent as the index itself was suspected of under-stating inflation.

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