* Inflation spike temporary
* Credit expansion decelerating
* Import decline outpacing export fall
* Positive sentiments at the bourse attracting foreign investors
The Central Bank issuing its monthly monetary policy statement says corrective measures taken to contain a balance of payments problem were bearing fruit with the economy growing 7.2 percent for the first six months of this year.
The bank ignored signs of a balance of payments crisis, ostracizing economists who raised red flags since June 2011, only to adopt a policy u-turn since February. This resulted in the necessary adjustments being more painful because of the late response of the authorities.
According to the Central Bank, the economy is now doing well with inflation at 9.5 percent last month being only a temporary domestic supply side phenomenon. It has kept policy interest rates steady for the time being.
"The concerted efforts by the Central Bank and the Government earlier this year to curb the high demand for imports and credit are yielding results. Reflecting the impact of the policy measures taken, credit obtained by the private sector has decelerated since the second quarter of 2012, and the policy measures in place are expected to help ensure that the growth of credit will be within the desired level at year end," the Central Bank said issuing its Monetary Policy Review for the month of September 2012.
"Compared to the average monthly credit expansion of about Rs.52 billion in the first three months, average monthly credit decelerated to around Rs.27 billion during the period from April-July. Benefiting from this moderation, growth of broad money has also decelerated to below 20 per cent in July for the first time this year.
"Nevertheless, the amount of credit available has been sufficient to facilitate reasonably robust economic activity, and as per estimates of the Department of Census and Statistics, the economy recorded a robust growth of 7.2 per cent during the first half of the year.
"Inflation, which increased in June and July, largely due to domestic supply disruptions has eased somewhat, recording a year-on-year change of 9.5 per cent in August. The downward revision of certain administratively determined prices, such as LP gas, and revisions to tariffs and levies on selected food items is expected to provide some respite from temporary increases in inflation arising from supply side shocks.
"Going forward, demand management policies adopted by the authorities are expected to help contain inflation within single digit levels.
"Growth of imports has decelerated considerably since April, outpacing the decline in export growth, resulting in a continued improvement in the balance of trade, such improvement, together with sustained inflows on account of workers’ remittances and enhanced tourist earnings have helped narrow the deficit in the current account balance.
"Further, the growing positive investor sentiment has resulted in cumulative net inflows of US dollars 229 million to the Colombo Stock Exchange, up to mid-September 2012, while proceeds of the fifth international sovereign bond issued in July and foreign investments in government securities amounting to US dollars 1,725 million in the same period have helped to ease pressure in the external sector, raising gross official reserves above US dollars 7 billion by end July.
"Taking into account the developments discussed above, the Monetary Board of the Central Bank of Sri Lanka was of the view that the current monetary policy stance was appropriate to deliver the expected results, and accordingly, at its meeting held on 17 September 2012, decided to maintain the policy rates of the Central Bank unchanged at their current levels. As such, the Repurchase rate would remain at 7.75 per cent while the Reverse Repurchase rate would remain at 9.75 per cent," the Central Bank said.
One year ago…
Since June 2011, economists and analysts have been warning of pressures on the balance of payments front. However, the Central Bank failed to take action. The Monetary Policy Review for September 2011, exactly a year ago, reproduced in full, shows how the Central Bank saw the economy then.
"Domestic economic activity continues to expand at a commendable pace, supported by improved external and domestic demand. Sri Lanka’s gross domestic product is estimated to have grown by around 8 per cent in the first half of 2011, with both industry and services sectors recording impressive growth. The contribution of the agriculture sector meanwhile has also been positive in the second quarter, following its contraction in the first quarter. The favourable outlook for domestic economic activity augurs well for domestic prices, going forward.
"Although commodity prices have continued to remain elevated in international markets, improved domestic supply conditions and the stability of the Sri Lanka rupee have helped contain domestic inflation. Both headline inflation and core inflation measured in terms of the CCPI (base*2006/2007) moderated in August 2011. Headline inflation declined to 7.0 per cent, year-on-year, from 7.5 per cent a month earlier, while core inflation declined to 7.8 per cent in August 2011 from 8.9 per cent in July. Meanwhile, on a 12-month moving average basis headline inflation increased slightly to 7.1 per cent while core inflation increased to 7.5 per cent in August 2011, from 7.0 per cent and 7.4 per cent, respectively, in July.
"Both exports and imports continued to grow at a rapid pace. Even though the deficit in the trade account has expanded, inflows into the services account as well as continued higher worker remittances have helped contain the deficit in the current account and maintain stability on the external front. Meanwhile, foreign exchange inflows to the capital and financial account are also continuing in view of projects being implemented in diverse sectors of the economy. Further, the Central Bank has also absorbed the proceeds of the sovereign bond issued recently, leading to the gross official reserves recording historically high levels.
"With respect to monetary developments, broad money (M2b) recorded a high year-on-year growth of 20.7 per cent in July 2011, led by the robust expansion of credit obtained by the private sector, which in turn reflects largely the notable expansion of domestic economic activity. It is expected that the moderation of world economic activity along with the slowing down of both advanced economies as well as emerging economies would have some dampening effect on credit and therefore monetary expansion in the period ahead. Nevertheless, if warranted, appropriate monetary policy action would be taken to contain monetary expansion, going forward.
"Having taken into consideration the recent macroeconomic developments including those discussed above, the Monetary Board at its meeting held on 15th September 2011, decided to maintain the Bank’s policy interest rates at their current levels. Accordingly, the Bank’s Repurchase rate remains at 7.00 per cent while its Reverse Repurchase rate remains at 8.50 per cent," the Central Bank said in September 2011.