CB holds rates steady

• Low inflation and moderate 1Q growth prompts Monetary Board to keep rates unchanged
• Says inflation expected to remain in mid-single digits for the rest of the year
• Hopes structural reforms will foster growth; nominal and real interest rates expected to reduce
• Money supply decelerates in May, reserves at $ 9.2 b by end June
• Rupee depreciates 3.6% against dollar in 1H

Central Bank Governor Dr. Indrajit Coomaraswamy.

The Central Bank yesterday decided to keep policy rates steady on low inflation and moderate first quarter growth numbers, but said it would remain vigilant of global market developments and possible spillover effects, while continuing to closely monitor domestic real economic activity.

Headline inflation, as measured by the Colombo Consumer Price Index (CCPI) and the National Consumer Price Index (NCPI), remained at low single digit levels, in spite of the transient acceleration mainly arising from the upward revisions to prices of domestic petroleum products and other administratively determined prices. Core inflation also remained subdued, and inflation expectations remain favourable, the Central Bank said in its latest Monetary Policy statement.  Although pressures on domestic food supplies during the off-season could exert some upward pressure on prices in the short-term, inflation is expected to remain at the desired mid-single digit levels during the remainder of the year and over the medium term, underpinned by firmly anchored inflation expectations and appropriate policy adjustments.

According to the provisional estimates released by the Department of Census and Statistics (DCS), the Sri Lankan economy grew by 3.2%, year-on-year, in the first quarter of 2018, compared to the revised annual growth rate of 3.3% in 2017.

Economic growth during the first quarter of 2018 was mainly driven by the Services and Agriculture-related activities while the Industry-related activities recorded a moderate growth.

“It is envisaged that the Government’s continued commitment to the implementation of structural reforms will help the economy to attain its potential over the medium term, amidst fiscal consolidation. The sustained recovery in the global economy is likely to support domestic economic growth, while the prevalence of a low inflation environment and an appropriately valued flexible exchange rate are also expected to facilitate higher growth,” the statement said.

Short-term interest rates increased recently, responding to the prevailing deficit liquidity conditions in the domestic money market. Yields of short-term government securities displayed mixed movements in the recent past, while other market interest rates appear to have stabilised at elevated levels. While appropriate open market operations will address short-term liquidity concerns, it is expected that nominal and real interest rates would gradually adjust downwards in line with the neutral policy stance of the Central Bank and the prevailing low inflation environment.

Meanwhile, the year-on-year growth of broad money supply (M2b) decelerated in May 2018. The growth of credit extended to the private sector by commercial banks, too, decelerated in the months of April and May 2018, following the festive season-led credit expansion observed in March 2018, the Central Bank said.

The moderation of earnings from exports alongside the increase in import expenditure resulted in an expansion of the trade deficit over the first four months of 2018. The recent growth in imports was largely driven by the importation of personal vehicles and gold, and the latter is expected to have been addressed by the imposition of the customs duty on gold imports. Earnings from tourism and workers’ remittances continued their positive growth momentum so far during the year.

Tightening global financial conditions prompted some outflows from the rupee denominated government securities market and the secondary market of the Colombo Stock Exchange (CSE), although primary market inflows resulted in a net overall inflow to the CSE so far during the year. Amidst these developments, the Central Bank recorded net foreign exchange absorption of $ 141 million from the domestic market in the first half of 2018.

With the successful issuance of the International Sovereign Bond (ISB) in April 2018, the receipt of the fifth tranche of the Extended Fund Facility with the International Monetary Fund (IMF-EFF), receipts from the divestiture of the Hambantota port and foreign exchange purchases of the Central Bank from the domestic market in early 2018, the gross official reserve position is estimated to have improved to around $ 9.2 billion by end June 2018, compared to $ 8 billion at end 2017.

So far during the year, the Sri Lankan rupee has depreciated against the dollar by 3.6%. Much of this depreciation was recorded since late April, reflecting the broad based strengthening of the dollar in the international market. The Central Bank intervened in the domestic foreign exchange market to address speculative behaviour in the foreign exchange market and the unwarranted volatility in the exchange rate.