The Central Bank; firm but not too tight

The Central Bank of Sri Lanka’s Monetary Board concluded the 4th policy review for the year yesterday. Meeting in the midst of an economic and quasi political crisis, the board that had previously hinted at further monetary tightening, decided to stay interest rates. Since August last year, the interest rate - The very short-term rates that banks trade at - have been raised by 9% to the presently seen elevated levels of 13.5% and 14.5% for the Standing Deposit Facility Rate (SDFR) and the Standing Lending Facility Rate (SLFR) respectively. This was not surprising given that CBSL had also alluded to the fact that market rates have overshot the required target. T-bill and bond yields have increased by close to 20%, nearly double the magnitude of the intervention.

Inflation too would not necessarily dissipate through higher rates this time around. The traditional monetary policy tool is inappropriate to counter high inflation as CBSL points out that the demand driven pressures present are miniscule in comparison to supply side factors and currency depreciation. Headline inflation is expected to increase from under 30% levels to 40% in the upcoming months. 

Many action points were also discussed in order to stabilise the exchange rate. Dr. Nandalal’s team, from previously taking unorthodox methods such as preventing open account import settlements and heavy moral suasion, have turned to more textbook methods. The previous methods have been noted as successful in lessening the gap between the unofficial black market and official foreign currency to rupee exchange rate. CBSL appears ready to intervene in hopes of stabilising interest rates and exchange rates through providing similar guidance.

CBSL has announced re-imposing margin requirements for Letters of Credit (LCs) being raised. While this will be done from 20 May onwards for non-essential imports, this paves the way for more free market favouring fluctuations, easing the burden on consumers cut off from access to certain imported products. Furthermore, a two-week period has been granted for locals to deposit foreign currency in FCY banking accounts or convert it in the banking system, lessening dollar leakages.

The holding limit of foreign currency by local resident individuals and other entities from $ 15,000 to $ 10,000 is also required with a proof of funds provided. These stern actions will be heavily reinforced by threat of fines and legal action in the event these conditions are violated. All this is expected to bring in dollars to the system easing the burden on Sri Lanka’s dollar reserves and also being favourable to consumer interests.

Similar to the new PM speech focusing on the losses of public enterprise, the Ceylon Electricity Board (CEB), Ceylon Petroleum Corporation (CPC) and gas providers together with the Water Board have been addressed on the matter of pricing adjustments. With the dollar shortage also being addressed simultaneously, the CBSL has provided the needed foreign exchange to clear the shipments of fuel and gas currently docked, that is the need of the hour. Given that revenue-increasing measures have not yet been taken on the fiscal front, the CBSL may need to dip into its pockets and print the financing needed. This is largely Government expenditure and CBSL assures transparency is kept this time around.

Despite the Minister of Finance abdicating the seat in this political turmoil, legal advisors for the debt restructuring have been confirmed and will be submitted to the existing Cabinet soon. Technical discussions are continuing with the overall Macro-Fiscal framework being discussed.