Sri Lanka state wage hikes argue for tightening policy: CB Governor

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ECONOMYNEXT – Sri Lanka held policy rates in October despite an output gap and weak private credit due to planned state sector wage hikes as well as currency weakness, Central Bank Governor Indrajit Coomaraswamy said.

The government has hiked state sector wages, brought forward planned hikes, despite an output shock from a currency collapse in 2018 and has promised another 50 billion rupee increase in state wages from January 2019.

“This is really a factor that argues for possibly hiking rates and that is the wage increases in the pipeline,” Coomaraswamy told reporters.

“We need to wait and see how that would all play out. And that’s a factor that actually argues for tightening.”

Sri Lanka kept its policy corridor at 7.00 for excess liquidity and 7.50 to inject new money at the last policy meeting where rates were cut by 50 basis points.

Governor Coomaraswamy said another factor that argued for holding rates was weakness of the rupee.

Factors that argued for loosening policy, was weak private credit. Externally there were signs of a ‘synchronous slowdown’, which argued for relaxation, he said.

“It gave space for domestic policy action,” Coomaraswamy said.

Sri Lanka is expecting growth to be around 2.5 to 3.0 percent in 2019 by various, which is lower than a so-called ‘potential growth’ of 5.0 percent.

Private credit has also slowdown down to below 10 percent. Broad money was growing at 7.7 percent, which was below the central bank’s expectations and argued for a cut.

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Coomaraswamy said inflation was also picking up, for which seasonal food prices was playing a part, which was a reason for caution.

Based historical trends Sri Lanka’s central bank generally prints money to keep rates down as either private credit recovers from the last balance of payments crisis, without an expansion of the budget deficit as in 2018, or private credit and budget deficits expands together as in 2015 triggering balance of payments troubles.

Sri Lanka has a monetary regime where inflation is targeted (a domestic anchor), with large volumes of money being injected suddenly to target call money rates, while operating a loose peg (external anchor) to build a ‘reserve buffer’.

The dual anchor conflicts then lead to currency pressure, downgrades, and difficulties in settling foreign debt. (Colombo/Oct14/2019)

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