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FINANCIAL CHRONICLE™ » DAILY CHRONICLE™ » Sri Lanka should hold policy rates till inflation falls: IMF

Sri Lanka should hold policy rates till inflation falls: IMF

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COLOMBO, Feb 13 (Reuters) - The International International Monetary Fund said on Wednesday that Sri Lanka's economic growth is slowing more than the government expects, and faces additional risks from high inflation, lower tax revenue and slow structural reforms.

The comments came a day after Sri Lanka said it would not pursue a new loan from the IMF after the global lender had indicated the government had made considerable progress in stabilising its finances.

The central bank has estimated the economy will grow 7.5 percent in 2013, accelerating from last year's estimated 6.5 percent.

However, the IMF said it expected the island-nation's economy to expand 6.25 percent this year, and estimated last year's growth slowed to 6 percent. The economy grew by a record 8.3 percent in 2011.

'The recovery will likely be constrained by the need to continue fiscal consolidation, high inflation, which limits the room for near-term monetary easing, and a continued slow recovery in Sri Lanka's main trading partners, particularly the U.S. and E.U.,' John Nelms, the head of IMF staff mission told reporters after concluding two weeks of consultations with Colombo authorities.

Nelms also projected the annual inflation rate would remain elevated at around 8 percent by end of this year, from the current near-high 9.8 percent hit in January.

The government needed to take measures to broaden and strengtehn its tax revenue base to support further fiscal consolidation, he added.

'Tax revenues have now fallen below 11.5 percent of GDP, among the lowest in the region, reflecting slowing activity, falling imports, exemptions, and issues with tax administration,' Nelms said.

The IMF said achieving the 2013 budget deficit target of 5.8 percent of GDP would be challenging amid weaker tax administration.

It also said the government needs to put loss-making, state-run Ceylon Electricity Board and Ceylon Petroleum Corporation on a more sustainable footing.

Global credit rating agencies have often said Sri Lanka's credit rating is constrained by high external debt and fundamental fiscal weaknesses, but it has been able to issue a handful of sovereign bonds in recent years which were oversubscribed by investors betting on a boom after the end of the country's 25-year civil war.

A $2.6 billion IMF loan programme agreed in 2009 has helped Colombo keep its inflation rate in the single digits, boosted its badly-depleted reserves to a record high and reduced the fiscal deficit and debt-to-GDP ratio to manageable levels. The final tranche of that loan was disbursed last summer.

Under the plan, Sri Lanka took a series of steps, including allowing a flexible exchange rate and raising interest rates.

(Reporting by Shihar Aneez; Editing by Kim Coghill)


(Reuters Messaging:


Director - Equity Analytics
Director - Equity Analytics

Feb 13, 2013 (LBO) - Sri Lanka should freeze policy rates until inflation starts to the fall International Monetary Fund said as country is suffering from the highest inflation generated by the central bank in over four years.

"Our view is that inflation levels of around 10 percent where we see them now is cause for holding interest rates cuts," IMF mission chief John Nelmes said.

"And the decision yesterday to keep monetary policy on hold, we support.

"And we think monetary policy should remain on hold for coming months till we see that inflation does start to turn the corner."

The central bank is expecting inflation to ease from March. Sri Lanka rupee peg broke from February 2012 onwards.

At 9.8 percent inflation in the past 12 months, Sri Lanka is seeing one of the highest price rises in Asia.

According to IMF data even Afghanistan has generated only 6 percent inflation last year. The war torn country is estimated to have grown at 12 percent, probably from a low base.

But compared to the past record of Sri Lanka's central bank when it routinely generated 20 percent plus inflation, ten percent is relatively mild.

High inflation and currency weakness - unless deliberately induced - necessarily indicates that a monetary authority is taking more wrong decisions than correct ones.

The central bank in mid 2012 started term auctions of liquidity, which some analysts say will prove deadly to both the exchange rate and inflation this year in continued.

Term auctions are to be used during periods of persistent liquidity shortages, which more often than not are brought on by currency defence, indicating that there is already pressure on the exchange rate. Such conditions require not a loosening but tightening of policy.

Last year Sri Lanka is estimated to have grown at about 6.0 percent the IMF said, though next year growth is expected to recover to 6.25 percent, a respectable pace given slow growth or recessions around the world.

"Underlying inflation has been on the rise," Nelmes said. "So the balance - even though growth is slowing - the balance for risks to inflation to us appears on the upside.

"Therefore the prudent step would be to maintain monetary policy on hold."

With exchange rate pressure easing, Sri Lanka's money market have started to see excess liquidity a situation that will anyway lead to market rates shifting from the 9.5 percent reverse repo rate at which money is injected, towards the 7.5 percent repo rate.

Sri Lanka has a soft-pegged exchange rate where large volumes of liquidity are created outside the policy rate through forex purchases.

Sri Lanka's three month Treasury bill rate fell further below the 9.5 percent overnight reverse repo rate to 9.10 percent Wednesday.

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