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Largely supported by services, growth in the first quarter of 2018 is expected to be 3.7%, the Central Bank said in its latest update, but insisted it was still below Sri Lanka’s economic potential.
Central Bank Governor Dr. Indrajit Coomaraswamy told reporters last Friday that policy rates had been kept unchanged by the Monetary Board as the impact of the previous decision to end a tightening bias last month had not yet filtered into the market but expressed confidence that interest rates would trend downwards over the next few months.
“It’sstill too early to see the impact on the relaxation of monetary policy in April. The overarching objective was to give a signal that the tightening bias was over and policy was moving to a neutral space. There is no change in circumstances to warrant a quick change in policy. Inflation will see an uptick but not above the 4%-6% target even though the numbers may challenge the upper level of the band around July. The slight uptick in credit and monetary aggregatewas due to seasonal trends. We have not observed much wage pressure and there is still an output gap. First quarter growth is still below the potential growth rate of the economy,” he said.
From the Central Bank’s point of view, risks will continue to be the danger of fiscal policy slippage, which for now seems to be on track, and vulnerabilities of the global economy. He also acknowledged that the Central Bank had intervened in the currency market after the rupee came under pressure. The rupee depreciated 3.2% up to 11 May. He pointed out that such depreciation was questionable given the high levels of reserves that the Central Bank had accumulated. The Central Bank has spent about $136 million defending the currency but has also bought about $30 million from the market resulting in net spending of $100 million.
“The reason why we intervened in the market is because we did not think that the movement of the rupee was well aligned with the fundamentals, that the rate of depreciation on those days was much higher than was warranted. Depreciation has a good and bad impact on the economy. Positive because it will help exports but we have to take into account the inflationary impact on the public. That is why we cannot let the rupee depreciate more than necessary. The real effective exchange rate is now near 100, we are not targeting that but what it tells us is that it is a competitive rate. That is why we intervened.”
The Governor also noted that the Central Bank would monitor the markets for the next fortnight or so to prevent any manipulations.
“For the transparent system we have to work well the market participants must also be disciplined and not try to manipulate the market. We will be very alert to see whether there is any manipulation and if we do notice any manipulation we will take very stern action. We just want to look and see, and understand the behaviour of transactions. Whether the behaviour of the market participants has in any way triggered unwarranted pressure on the exchange rate. If there has been such behaviour we obviously have to discourage it.”
The Central Bank would also monitor vehicle imports, which saw an increase in the first quarter but officials noted it could be seasonal. However, the Central Bank stands ready to employ macro-prudential measures if necessary but the Governor was optimistic the dual developments of currency depreciation and a hike in fuel prices would dampen demand. The Central Bank also supported a step by the Government to impose a tax on gold imports noting that if previous trends had continued as much as $1 billion in foreign exchange could have been lost and argued that the steep increase in gold imports was not reflected in the exports which were only $18 million.
“There is a lot of money flowing out of the emerging markets, much of it to the US and that will probably continue. In terms of the prognosis of the dollar there seems to be a debate. There are those who feel that there will be strengthening of the dollar while others feel it is really a re-pricing of the dollar in the first quarter because the US economy did well and Europe and Japan did not do quite so well as expected. That has affected us.”
Even though the US has decided to pull out of the Iran nuclear deal, if European signatories and others remain Iran’s oil production could continue, Dr. Coomaraswamy opined, which could reduce prices but that remained to be seen.
“The largest producer now to a great extent is US shale oil but there is a bit of an issue there because some of the shale is mined in remote parts of the country and it is taking some time to build the infrastructure needed to move the oil to market. Once that is resolved the US will become the swing producer. We did a projection with oil at $70-$75 per barrel and the inflation pass through was 1%-1.5%. We are now at 3.5% so we may get up to about 5.3% so we are still within range.”
Responding to questions on the possibility of the Samurdhi Bank being brought under the Central Bank, both the Governor and other officials stated at present there was no such policy but that the monetary institutions would work with other stakeholders to improve regulatory oversight.
“It is something that needs to be studied. I think there is a concern that there should be better regulation of the Samurdhi Bank and we should have better guidelines. As to who should do it and how it should be done, that needs to be worked out. The Central Bank can play a very constructive role in helping to develop regulations, directions, guidelines and helping to train the staff. We have to make sure the right regulatory framework is put in place,” he said, acknowledging that Samurdhi Banks could see operations costs increasing if they were brought under the higher standards of the Central Bank.
Amanagement committee already exists to issue guidelines but a new committee including officials of the Finance Ministry has been appointed to decide how matters could be better regulated.
