The Central Bank kept monetary policy rates unchanged while government borrowings from domestic banks continue to surge, crowding out the private sector. However, the bank is optimistic that the government’s domestic borrowings would decline over the coming months, creating space for a monetary policy rate cut which would stimulate private sector led economic growth.
"The growth of broad money supply (M2b) decelerated to 17 per cent in February 2013, its lowest level in 25 months. Within broad money, credit extended to the private sector increased by Rs. 18 billion in February, recording a y-o-y growth of 13.3 per cent. Meanwhile, credit obtained by the public sector amounted to Rs. 36.7 billion in February, but with expected adjustments to administratively determined prices and continued fiscal consolidation, the reliance of the public sector on bank financing is expected to decline in the coming months," the Central Bank said yesterday (16) releasing the Monetary Policy Review for April 2012
"The resulting availability of funds, together with foreign capital raised by the banking sector in recent months would provide the necessary stimulus to strengthen private sector activity.
"Monetary policy measures taken so far indicate that expected results are being realised, providing reasonable stimulus for a higher economic growth. At the same time, further deceleration of demand driven inflation on a sustainable basis would provide space for further easing of monetary policy," the Central Bank said.
"Accordingly, the Monetary Board at its meeting held on 12th April 2013, was of the view that the current monetary policy stance was appropriate and decided to maintain the Repurchase rate and the Reverse Repurchase rate of the Central Bank at their current levels of 7.50 per cent and 9.50 per cent, respectively," it said.
The Central Bank painted a positive picture for the economy for the rest of the year, although prices would be affected by upcoming utility price revisions.
"The Sri Lankan economy grew at a robust rate of 6.4 per cent in 2012 amidst significant challenges, registering a strong average growth rate of 7.5 per cent for the period 2010-2012. This growth was supported by a resilient Agriculture sector, which grew amidst adverse weather conditions, and by sustained Industry sector growth. Although the tourism and finance sub-sectors grew rapidly, the Services sector recorded moderate growth due to low external trade activities in 2012," the bank said.
"As projected, year-on-year (y-o-y) inflation for March 2013, fell significantly, mainly due to the base effect and reflecting a continuing decline of food prices. Headline inflation (y-o-y), which remained at 9.4 per cent on average for 9 months declined to 7.5 per cent, while core inflation (y-o-y) also declined to 6.8 per cent in March from 7.4 per cent in the previous month. Both headline and core inflation has remained at single digit levels for 50 consecutive months. Inflation is expected to remain at these benign levels supported by prudent demand management policies, although the proposed revisions to administered prices are likely to exert some upward pressure on price levels.
"The balance of payments (BOP), which turned around in 2012 recording a surplus of US dollars 151 million at end 2012, remains in surplus so far this year and is expected to improve further with increased foreign currency inflows. During the year so far, the Central Bank has absorbed US dollars 560 million on a net basis, raising gross official reserves to US dollars 6.9 billion, which is equivalent to 4.5 months of imports."
According to the 2013 budget proposals the government will not seek foreign commercial loans this year after borrowing Rs. 109.5 billion in 2011 and Rs. 128 billion in 2012.
With the budget deficit estimated at Rs. 507.4 billion this year, the government hopes to raise Rs. 86 billion from foreign sources to finance the deficit, a sharp decline from Rs. 205.6 billion estimated for last year, while domestic borrowings are estimated at Rs. 421.4 billion, almost doubling from 259.6 billion in 2012.
Non bank domestic borrowings are expected to carry the weight of the deficit financing, surging to Rs. 289.4 billion this year from 84.6 billion in 2012.
According to CT Smith Stockbrokers, benchmark Treasury bill yields are expected to decline by 100bps by the third quarter of this year, however, government deficit financing would push rates up by 50bps by the fourth quarter.
With the government prioritising growth over inflation, CT Smith believes monetary policy rates would be cut by 50 to 75bps this year. Inflation is expected to range within 7 to 10 percent this year, it said.
Economists at a recent forum said Sri Lanka needed to increase export earnings and foreign direct investment in order to avoid a debt-trap.
They argued that fiscal policy and monetary policy needed to undergo a structural shift so as to create a macroeconomic environment that would be conducive to both exports and FDIs, as heavy borrowings led economic growth could not be sustained for long. Upholding the rule of law was also cited as a critical ingredient.
Senior Economist Prof. A.D.V. de S. Indraratne said the twin deficits of the trading account and budget posed several problems for the economy.
"How do we meet these deficits? By borrowing or with FDI flows? While FDI has been flows have been low, borrowing has been increasing. Both foreign debt and domestic debt have been falling as a percentage of GDP but their absolute amounts have been rising significantly and our debt burden as measured by the debt service ratio has not been abating. And the implication is that our future exports have to pay for this increasing foreign debt, and hence we need to increase exports to meet these obligations in the future.
"Borrowing that leads to spending on non-tradable goods, result in rising interest rates and rising inflation because both increase aggregate demand. Government spending would crowd out private credit and thereby private investment and on one hand and raise the production costs of exports on the other and make them internationally less competitive," the President of the Sri Lanka Economics Association said.
Government debt, as a percentage of GDP, increased to 79.1 per cent in 2012 compared to 78.5 per cent recorded in the previous year and 77.7 per cent projected in the Medium Term Macro Fiscal Framework, largely due to the depreciation of the rupee, the Central Bank aid.
In nominal terms, the outstanding government debt increased notably by 16.9 percent to Rs. 6,000.1 billion at end 2012 from Rs. 5,133.4 billion at end 2011. As a percentage of GDP, domestic debt was 42.6 per cent and foreign debt was 36.5 per cent, whereas the corresponding ratios in the previous year were 42.9 per cent and 35.6 per cent, respectively.