Stability at these rates

Under normal conditions there is a case to be made for a stimulus. Mainly, to fix deteriorated business confidence. The Purchases Managers Index has continued to fall on a month-on-month basis. According to this gauge of the coming months anticipated consumer demand and economic sentiment, a monetary boost may be just what the doctor just ordered. 

With increased lending rates, deteriorating economic conditions, restrictions on imports, and banks’ cautious lending practices as a result of high debt impairment provisions, the economy is sluggish to say the least. A significant decrease in bank lending, which has continually grown negatively since June 2022. As a result, from June to September 2022, the system’s total private sector credit decreased by Rs. 177.6 billion. Consistently declining private sector loan growth further reduces the likelihood of economic recovery.

Having seen the number of new enterprises in industries such as real estate and insurance dip from October 2022, employment too continue to decline due to a surge in retirements, emigrations and resignations; the nation’s skilled labour pool is now at risk. Additionally, the country’s living standards have been badly hit by the protracted economic slump and elevated levels of poverty, which is harmful to economic recovery. Therefore, economic incentives may be necessary.

Moreover, any steps that might lead to additional monetary tightening can be fully avoided, opening the door for Central Bank (CBSL) to test monetary stimulus through slack monetary policy. Despite a 0.4% gain in non-food prices, the drop in food items by 0.8% was a major factor in inflation turning around. Due to the appropriately tight monetary conditions, the scaled-down inflation indicates that any previously present demand pressure has now totally dissipated, while cost-push inflation has also begun to gradually drop off. 

Therefore, in order to revive the demand for private sector credit and heal the severely damaged Sri Lankan economy, proper direction for a reduction in interest rates is crucial at this point.

Additionally, it is anticipated that the United States FED will use a less strenuous monetary tightening stance at the forthcoming FOMC sessions, potentially signalling a pause in the rise in interest rates before the recession really hits. As a result, there is a good likelihood that CBSL, which is presently on the route to reaching macroeconomic stability, will choose a lax monetary policy in line with the general mood of the world to inform market participants of the way forward. However, this comes at a cost that the Central Bank should anticipate.

These recent developments are solely attributable to CBSL’s ongoing purchase of Treasury securities, which serves to infuse liquidity into the banking system. Accordingly, CBSL injected Rs. 129.9 billion on 15 November, on one day alone, which has since caused secondary market rates to cool off. In the past, CBSL has used a number of methods to add liquidity to the system, including overnight repo injections, term repo injections, and outright bond purchases to increase Government securities up to Rs. 2.6 trillion. 

Therefore, a loosening of the monetary policy by CBSL may not result in the expected results given the current currency crisis and reduced liquidity.

Official Reserve Assets continue to decline on a month-on-month basis, dropping from $ 1.8 billion reported in September to $ 1.7 billion in October by $ 75 million. Therefore, CBSL’s monetary easing at this time may harm the country’s already depleted foreign reserves. As a result of the ambiguous economic, social, and political environment, there were still little foreign inflows. 

Net foreign inflows into the equity market between June and November 2022 totalled Rs. 18.7 billion, while increases in foreign holdings of rupee bonds totalled Rs. 22.1 billion during the same period, showing that the foreign attraction is not yet strong enough to justify a policy rate cut at this time. The CBSL is at a crossroad.