ECONOMYNEXT – Sri Lanka did not cut rates, despite money and credit growth stabilizing, because global interest rates were rising, and the central bank wanted to watch how budget deficit was behaving, and oil prices were also high, Governor Indrajit Coomaraswamy said.
"Clearly if there has been a loosening of monetary policy it would not be wise to loosen monetary policy at the same time," Central Bank Governor Indrajit Coomaraswamy said.
In 2015 the central bank cut rates in April and poured tens of billions of liquidity tied up in term repos as budgets deteriorated and oil prices were cut amid warning from economic analysts. ( (Sri Lanka on a risky pro-cyclical path as credit expands: Bellwether)) at the time.
The central bank then generated a balance of payments crisis and high inflation despite soft global commodity prices as the rupee collapsed.
This week the central bank held rates unchanged, as political instability exploded with the ruling coalition suffering humiliating defeat amid massive securities scam and alleged cover up. and the ruling coalition was at a cross-roads over its future direction.
Coomaraswamy said a quick return of political stability will help. Investors would prefer to see political stability he said.
He said advanced economies were recovering and rates were moving up as central banks ‘normalized’ monetary policy, especially in the US.
"Given that we seeing international interest rates going up," Coomaraswamy said. "In a context where money is beginning to move from emerging markets generally to advanced markets because of interest rate developments to reduce rates could lead to incentivising outflows."
Foreign bond holders had already been selling amid political uncertainty over the last few days as well as moves to tax them. But now it has been indicated that they may not be taxed.
The central bank said up to February 15 there had been a 4.2 million outflow from bond markets compared to over 400 million inflow in 2017.
The central bank saw a ‘potential growth rate’ for Sri Lanka at 5.75 percent and with the economy was growing at below 4.0 percent, showing that there was an ‘output gap’.
"Particularly with the output gap we have seen an easing of inflation," Coomaraswamy said.
New inflation was also now falling with credit slowing, with the effects of two years of money printing and currency collapse having generated over 17 percent inflation from the beginning of 2015. An The central bank has however attempted to deflect responsibility by blaming coconuts for inflation resorting tactics seen by British classical Mercantilists centuries ago who blamed inflation on a drought (cost-push) while money was printed for the Napoleonic wars, analysts say.
Meanwhile Governor Coomaraswamy said private credit was growing at 14.7 percent by December and broad money growth had slowed below 18 percent.
Analysts say the central bank had been mopping up excess liquidity from dollar purchases over the last year, building up 1.6 billion dollars of forex reserves, indicating that banks are loaning less than the total inflows of repayments and new deposits, though the purchase of central-bank held Treasury bills.
However inflation was still created by the central bank intervening in forex markets at increasingly higher rates, preventing the currency strengthening and weakening it, in bid to target a Real Effective Exchange rate and creating more inflation.
The weakening of the exchange rate pushes up the price of exported commodities like tea (of which there is a large surplus) as well as imports.
Governor Coomaraswamy said the Reel Effective Exchange Rate had also eased.
Analysts had said that the REER index would fall with many East Asian currencies strengthening through but the political effect of inflation created in the meantime would be deadly. (Colombo/Feb16/2018)