A further export slowdown would put additional pressure on the economy as domestic demand has already shown signs of cooling following a series of tough policy measures earlier this year, Dr. P.B. Jayasundera told Reuters in an interview.
“Demand has drastically reduced. We must watch May and June data seriously and see whether there is a need for any softening in monetary policy,” said Jayasundera, the highest technocrat in President Mahinda Rajapaksa’s Government. “A policy rate reduction may be considered in July or August.”
The Central Bank has raised key policy rates twice since February to more than two-year highs, restricted banks’ lending, and allowed flexibility in the rupee exchange rate in a bid to curb inflation, reduce the trade deficit and avert a balance-of-payments crisis.
The measures have had mixed results.
Imports contracted in April on a year-on-year basis for the first time in 25 months, shrinking 3.3 per cent, while exports contracted 9.2 per cent. As a result, the trade deficit grew at its slowest pace in 17 months.
Growth in private sector credit in April, meanwhile, slowed to Rs. 18.7 billion ($ 141 million), well below the average monthly growth of Rs. 51.8 billion in the first quarter of this year.
But the move to a more flexible exchange rate has seen the rupee currency tumble to record lows, adding to inflationary pressures and swelling the country’s oil import bill.
The currency has skidded nearly 17 per cent since 21 November, when the Government announced a three per cent devaluation. On Thursday, the rupee was trading at around 132 to the US dollar.
The Government and Central Bank have clashed previously on foreign exchange policy – the President announced the devaluation without consulting the bank – but it is not clear if they are in agreement on the direction of monetary policy.
Jayasundera said the drastic depreciation of the rupee combined with a tight monetary policy was a “killer” as it had already reduced consumer demand. He also said he believed the rupee has hit a bottom and would recover to around 125 in the medium-term.
“In my view, the exchange rate has reached its maximum and will stabilise in the medium term at the earlier expected level,” Jayasundera said, referring to 125 per dollar level.
The Central Bank kept policy rates unchanged on Wednesday, as expected, saying earlier measures were enough to moderate both credit and the trade deficit expansion.
It spent more than $2.6 billion from its reserves trying to defend the rupee in the second half of 2012.
The International Monetary Fund, which had long pressed the central bank to allow flexibility in the rupee exchange rate, is expected to release the last tranche of a $ 2.6 billion loan to Colombo if it is satisfied with the performance of the government and the economy.
The last tranche is worth about $ 420 million.