Friday, June 24, 2016

Sri Lanka maintains rate, growth in line with expectation

    Sri Lanka's central bank left its key policy rates steady, as expected, saying growth in the first quarter was broadly in line with expectations while inflation is expected to ease and remain in mid-single digits in the medium term.
     The Central Bank of Sri Lanka last raised its key rates, the Standing Deposit Facility Rate (SDRF) and the Standing Lending Facility Rate (SLFR), by 50 basis points in February to 6.50 percent and 8.0 percent, respectively.
     Sri Lanka's inflation rate picked up speed in May to 4.8 percent from 3.1 percent in April, an acceleration that was expected due to May's increase in Value Added Tax (VAT) to 15 percent from 11 percent and the removal of certain exemptions to raise government revenue.
    The International Monetary Fund (IMF) - which earlier this month approved aid of US$1.5 billion, with immediate payment of $168.1 million, to help Sri Lanka meet balance of payment needs until it can adjust its macroeconomic policies - forecasts average inflation this year of 4.1 percent, up from 0.9 percent in 2015.
    For 2017 the IMF sees inflation rising to 5.3 percent before easing to 5.1 percent in 2018, 5 percent in 2019 and the same in 2020.
    Although Sri Lanka's economy expanded by an annual rate of 5.5 percent in the first quarter of the year, up from 2.5 percent in the previous quarter, the IMF said the economy was beginning to show signs of strain from the weak external environment and the challenges of policy adjustment.
    The IMF forecasts annual growth of 5.0 percent this year and the following two years compared with 4.8 percent last year.
    The linchpin of the IMF-led reform program is a reduction in Sri Lanka's fiscal deficit to 3.5 percent of Gross Domestic Product by 2020 from 6.9 percent in 2015 by rebuilding tax revenues, controlling expenditures and putting state enterprises on a more commercial footing.
    Revenue last year rose 1.5 percentage points to 13.1 percent of GDP, but this was mainly due to one-off measures and taxes from a temporary surge in vehicle imports. Meanwhile, expenditures rose by 2.1 points to 19.9 percent of GDP.
    The IMF also wants Sri Lanka to commit itself to a flexible exchange rate that will enable it to adjust to external forces and allow the central bank to rebuild foreign exchange reserves and focus more closely on price stability.
    Sri Lanka's rupee has been facing downward pressure for months due to capital outflows and has been depreciating steadily since late August until early this month when market sentiment improved following the IMF's approval of the Extended Fund Facility (EFF), which the central bank expects should help strengthen the country's external position.
    The rupee was trading at 146.6 to the U.S. dollar today, down 1.7 percent this year.
    Sri Lankan shares have been also been under pressure recently, with the benchmark Colombo index hitting its lowest close in two months on Thursday in response to a downwards revision of Sri Lanka's outlook to negative from stable by Moody's and a government proposal from June 15 to reintroduce capital gains, especially on land sales.

   The Central Bank of Sri Lanka issued the following statement:

"According to provisional estimates of the Department of Census and Statistics (DCS), the Sri Lankan economy grew by 5.5 per cent, in real terms, in the first quarter of 2016 compared to the growth of 2.5 per cent recorded in the last quarter of 2015. Economic growth was mainly supported by the expansion of Industry and Services related activities, which grew by 8.3 per cent and 4.9 per cent, respectively, during the first quarter of 2016 in value added terms. Meanwhile, Agriculture related activities recorded a moderate growth of 1.9 per cent during this period. The growth rate recorded in the first quarter was broadly in line with expectations for the year.

As anticipated, inflation increased in the month of May reflecting the impact of the increase in Value Added Tax (VAT) and the removal of certain exemptions applicable on VAT and Nation Building Tax (NBT), as well as the supply side disruptions due to adverse weather conditions. Accordingly, the Colombo Consumers’ Price Index (CCPI, 2006/2007=100) based headline inflation increased to 4.8 per cent, year-on-year, in May 2016 from 3.1 per cent in the previous month, while the National Consumer Price Index (NCPI, 2013=100) based headline inflation also increased to 5.3 per cent, year-on-year, in May 2016 from 4.3 per cent in the previous month. Core inflation as measured by both CCPI and NCPI also increased in May 2016 mainly reflecting the impact of revisions made to the tax structure by the government. In spite of these transitory price movements, inflation is expected to moderate in the period ahead and remain in mid-single digits in the medium term supported by appropriate demand management policies.

In the monetary sector, the year-on-year growth of broad money (M2b) decelerated to 18.2 per cent in April 2016 compared to 18.9 per cent recorded in March 2016. The expansion in credit to the private sector and the government remained key drivers of broad money growth, while credit to public corporations recorded a repayment during the first four months of the year. Credit extended to the private sector by commercial banks grew by 28.1 per cent in April 2016 on a year- on-year basis, although in absolute terms, disbursements in April 2016 were limited to Rs. 27.4 billion compared to Rs. 87.7 billion in the previous month. Short term money market rates displayed some stabilisation, while the upward trend observed in other retail market interest rates continued reflecting the gradual transmission of the monetary policy measures that were taken previously, amidst low levels of rupee liquidity in the domestic money market.

On the external front of the economy, the deficit in the trade account contracted by 2.4 per cent during the first four months of 2016, on a year-on-year basis, as the decline in imports was greater than the contraction in exports. Earnings from tourism were estimated to have increased by around 18.4 per cent during the period from January to May 2016, while workers’ remittances increased by 4.7 per cent during the period from January to April 2016. Gross official reserves were estimated at US dollars 5.6 billion by end May 2016.

Meanwhile, the Executive Board of the International Monetary Fund (IMF) approved a three year Extended Fund Facility (EFF) of SDR 1.1 billion (approximately US dollars 1.5 billion) for Sri Lanka on 03 June 2016 to support the balance of payments (BOP) position and the broad economic reform agenda of the government. Following the approval of the IMF-EFF and the resultant improvement in market sentiments, the Sri Lankan rupee appreciated against the US dollar so far during the month of June 2016. Going forward, the EFF and other multilateral and bilateral credit facilities, along with the planned structural reforms and the realisation of the envisaged non- debt-creating capital inflows, are expected to strengthen the country’s external position. The expected improvements in the fiscal sector will also assist the Central Bank policies in maintaining macroeconomic stability on a sustainable basis.

Taking into consideration the developments discussed above, the Monetary Board, at its meeting held on 24 June 2016, was of the view that the current monetary policy stance of the Central Bank is appropriate, and accordingly, decided to maintain the Standing Deposit Facility Rate (SDFR) and the Standing Lending Facility Rate (SLFR) of the Central Bank unchanged at 6.50 per cent and 8.00 per cent, respectively. The Monetary Board will continue to closely monitor developments in the domestic as well as global markets and make appropriate adjustments to the monetary policy stance, as necessary."


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