Thursday, December 28, 2017

Sri Lanka holds rates, "cautiously" monitoring economy

     Sri Lanka's central bank left its policy rates steady, as widely expected, but signaled a readiness to change its stance by saying it was "cautiously" monitoring the economy and would take necessary policy action, if warranted.
     The mention of cautiously monitoring the economy was not included in last month's review by the Central Bank of Sri Lanka's (CBSR) monetary board when it merely said it's decision was consistent with the objective of keeping inflation at mid-single digit levels and supporting economic growth.
      The central bank's decision to maintain its Standing Deposit Facility Rate (SDFR) at 7.25 percent and the Standing Lending Facility Rate (SLFR) at 8.75 percent comes after the International Monetary Fund (IMF) earlier this month said the central bank should maintain a tightening bias "until clear signs emerge that inflation pressures and credit expansion have subsided."
       Last month CSBR Governor Indrajit Coomaraswamy told Reuters he did "not yet" see a need for further rate hikes as core inflation is low. But if there is a rise in core inflation or wage pressures from headline inflation, he added the central bank would have to act.
       Sri Lanka's headline inflation rate eased to 7.6 percent in November from 7.8 percent in October - the highest level since February 2013 - tough the rate still remains elevated due to higher food prices from supply disruptions due to bad weather.
       Although the central bank expects headline inflation to remain "at somewhat elevated levels" in the near term, it expects inflation to return to its desired level toward the end of first quarter 2018.
       Core inflation eased to 5.2 percent in November from 5.8 percent in October, indicating subdued demand pressure, the CBSR said.
        The CBSR began raising its rates in February 2016 to slow growth in private sector credit and has raised rates three times since then, most recently in March this year, by a total of 125 basis points. The central bank described the March hike as a precautionary move to curb the build-up in inflation expectations after bad weather had pushed up headline inflation.
       The central bank is slowly moving towards a flexible inflation targeting framework that calls for inflation in a range of 4-6 percent in the medium term, a range that is consistent with the inflation target bands that have been set out under its arrangement with the IMF.
       Helped by the central bank's more flexible exchange rate regime, Sri Lanka's export earnings registered their fourth consecutive month of double digit growth in the third quarter when the overall economy slowed to 3.3 percent annual growth from 4.0 percent in the second quarter.
       Although near-term prospects remain subdued, the central bank expects the economy to pick up speed next year as agriculture bounces back from a bad harvest and exports and foreign direct investments rise.
        Last month the CBSR lowered its 2017 growth forecast to between 4.0 and 4.5 percent from 4.5 percent.
       The Sri Lankan rupee has been depreciating steadily since September last year though it has strengthened in the last month. But it fell in response to today's central bank's review to trade at 153.5 to the U.S. dollar from 152.4 yesterday.
        In 2017 the rupee has depreciated 3.3 percent.

        The Central Bank of Sri Lanka issued the following statement:

"Considering recent macroeconomic developments, the Monetary Board, at its meeting held on 27 December 2017, was of the view that the current monetary policy stance is appropriate and decided to maintain the policy interest rates of the Central Bank of Sri Lanka at their present levels. However, the Central Bank will continue to cautiously monitor the developments in the economy and take necessary policy actions, if warranted.

The key sectoral developments considered in arriving at the decision by the Monetary Board are discussed below.

According to the provisional estimates of the Department of Census and Statistics (DCS), the Sri Lankan economy recorded a lower than projected growth for the third quarter of 2017. Accordingly, the economy grew by 3.3 per cent, year-on-year, in the third quarter of 2017, compared to 4.0 per cent recorded in the second quarter of 2017. Economic growth in the third quarter was mainly driven by the moderate expansion in the Industry and Services sectors, while the Agriculture sector continued to record a negative growth on account of weather related disruptions. Although near term growth prospects remain subdued, it is anticipated that the economy would recover in 2018 due to continuous surge in exports and investments induced by foreign direct investments. The recovery in the Agriculture sector would also support the growth performance in 2018.

Headline inflation decelerated in November 2017 as expected, but still remains at an elevated level in terms of both National Consumer Price Index (NCPI) and Colombo Consumer Price Index (CCPI), reflecting the impact of higher domestic food prices. Nevertheless, core inflation remained checked indicating subdued demand pressures, reflecting the effectiveness of the tight monetary policy stance maintained by the Central Bank. Although high food prices stemming from supply disruptions could cause headline inflation to remain at somewhat elevated levels in the immediate future, inflation is expected to return to the desired level towards the end of first quarter of 2018.

The growth in broad money supply has slowed down substantially in November 2017 caused mainly by the deceleration in the growth of private sector credit extended by commercial banks as expected, responding to the tight monetary policy stance. Meanwhile, the yields on government securities have adjusted downward from the peak levels, correcting some disparity that existed between the policy rates and the yields on government securities. Other market interest rates are also expected to adjust further downwards in line with the yield rates.

Export earnings continued its growth momentum registering double digit growth for the fourth consecutive month, partly benefiting from the implementation of a more flexible exchange rate regime. However, the trade deficit widened during the first ten months of the year, largely on account of the notable increase in import expenditure, particularly due to supply side constraints mainly arising from weather related disturbances, offsetting the positive impact of improved performance in export earnings. However, easing the pressure on external accounts to a certain extent, sustained inflows to the financial account in terms of inflows to government securities market and the Colombo Stock Exchange (CSE) were observed. The receipt of the fourth tranche of the Extended Fund Facility (EFF) Programme of the IMF in December 2017 and inflows on account of divestment of Hambantota Port helped further strengthen the Balance of Payments (BOP). Given these developments and reflecting the continued foreign exchange purchases on a net basis by the Central Bank amounting to around US dollars 1.7 billion, gross official reserves are estimated to improve to around US dollars 7.8 billion by end December 2017. The Sri Lankan rupee depreciated against the US dollar by 1.9 per cent as at 27 December 2017. During 2017, the Central Bank has been able to turn around the trends of declining gross official reserves and recording BOP deficits during 2015 and 2016 by registering a significantly large BOP surplus, while maintaining a more flexible exchange rate regime under the current enhanced monetary policy framework, which involves transiting towards a Flexible Inflation Targeting (FIT) framework.

As per the available indicators, the fiscal sector recorded notable improvements in 2017, particularly due to increased revenue collection, which has enabled recording a surplus in the primary balance. Although some slippages in key fiscal balances in comparison to original estimates are expected in 2017 mainly as a result of expenditures related to relief measures and higher interest payments, fiscal consolidation is expected to continue in the medium term supporting macroeconomic stability.

In view of the above, the Monetary Board decided to maintain the Standing Deposit Facility Rate (SDFR) and Standing Lending Facility Rate (SLFR) of the Central Bank at their current levels of 7.25 per cent and 8.75 per cent, respectively."


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