Easing Monetary Policy Vs. Averting BOP Crisis

• CBSL Plans 7.5% Growth, But Credit Decelerates to 11%

By Paneetha Ameresekere
The question as to whether there is space to cut policy rates further at the expense of creating a possible balance of payments (BoP) crisis similar to that which gripped the country two years ago, cropped up at a discussion this reporter had with a Central Bank of Sri Lanka (CBSL) economist (source) who didn’t want to be named on Thursday (May 30).
This was in the context that the tightening of monetary policy last year impinged on growth which had been elaborated in CBSL’s 2012 Annual Report, the source alleged.
CBSL which had previously projected that the economy would grow by 8% last year, however saw this decline by 160 basis points (bps) to 6.4%, mainly caused by the tightening of fiscal and monetary policies, that led to by a burgeoning trade deficit of US$ ($) 10 billion, equivalent in value to Sri Lanka’s total export basket.
Enhanced growth is needed to increase a country’s wealth.
Sri Lanka’s economy grew by 8% in 2010, 8.2% in 2011, before falling to 6.4% last year, while the trade deficit contracted to $ 9 billion.
CBSL projects that the economy will grow by 7.5% this year.
But credit to the private sector, considered as the engine of growth, which in the “boom” year 2011 grew by 34.5%, however in the first quarter of this year faltered to 11%, lower than the 17-18% targeted to by CBSL for the full year.
Under the circumstances is there room to cut policy rates further in order to spur growth? this reporter asked him. “We have to look at all of the economic variables in its totality before deciding on this issue,” was the source’s reply.
The trade deficit is a matter of concern, made worse by falling exports, he said.
Policy Rates
Be that as it may, since December of last year and up to now, CBSL has cut policy rates by 75 bps in order to spur growth, but credit has not yet taken off. There is a contraction in demand, the source admitted.
Another CBSL source however said that there is no immediate space for another rate cut.
Yet another CBSL source said that there may be several factors that will have to be first taken into account before arriving at the decision of making a further policy rate cut.
Among those was inflation, ie whether inflation was receding and thereby making conditions opportune for a further rate cut? Another was whether private sector credit growth was low, thereby trying to induce credit growth also by a rate cut.
“Economic growth and the impact the recent electricity hike would have on the economy among others, also have to be considered,” the source further said.
Yet another source said that the reason why Government of Sri Lanka’s (GoSL’s) domestic borrowings are high was because there was slack demand from the private sector.
If however private sector credit was growing at an accelerated pace, then GoSL would have had to look at other sources other than the domestic banking sector for its funding requirements, the source opined.
Govt. Borrowings
This was in the context that at Wednesday’s (May 29) Treasury (T) Bill auction, the weighted average yields (WAYs) of the three tenures on offer held, because of over-borrowing by GoSL, according to a CBSL source.
Otherwise the WAYs would have had declined by around two bps, the source alleged.
Though GoSL originally had Rs. 15,000 million worth of maturing T Bills for reissue, they increased that quantum by more than 1½ times to Rs. 23,652 million at Wednesday’s auction.
Another CBSL source said that GoSL has now met 50% of its approved borrowing limits for the year. “There is a lag period before a decline in policy rates could have an impact on real interest rates,” the source further said. “Also, there is an interest rate mismatch where previous deposits were bought at a higher rate, so banks cannot immediately reduce their lending rates,” the source added.
Another contributory factor is the tight money supply situation, the source said.
Money supply however may be increased by CBSL subscribing to T Bills, but that may create further inflationary pressure on the economy.
However a source said that demand side inflationary pressure on the economy is subdued. Also, continued easing of monetary policy which translates to credit made available cheap may also lead to a BoP crisis like what happened two years ago as the Sri Lankan economy runs a trade deficit.
The rumour is that there may be no more policy rate cuts for the next three months after last month’s 50 bps scaling down of policy rates, a market source said.
Further easing of monetary policy which translates to credit made available cheap may lead to a BoP crisis like what happened two years ago as the Sri Lankan economy runs a trade deficit. But a tight liquidity situation may be a disincentive to borrowings due to borrowings becoming expensive. That in turn will impact investments, higher earnings and the creation of employment opportunities, whilst slowing down growth.
Meanwhile a CBSL source alleged that inflation measurement which is in the domain of the Census and Statistics Department (CSD) had obtained the advice of an IMF consultant to help it to improve its reporting standards.
Some 373 items go to make the inflation basket, he said. But apparently what those 373 items are, are allegedly not divulged to the public.
CSD wants to make inflation measurement, which is currently confined to Colombo, islandwide, the source further saidEasing Monetary Policy
Though GoSL originally had Rs. 15,000 million worth of maturing T Bills for reissue, they increased that quantum by more than 1½ times to Rs. 23,652 million at Wednesday’s auction.
Another CBSL source said that GoSL has now met 50% of its approved borrowing limits for the year.
“There is a lag period before a decline in policy rates could have an impact on real interest rates,” the source further said. “Also, there is an interest rate mismatch where previous deposits were bought at a higher rate, so banks cannot immediately reduce their lending rates,” the source added.
Another contributory factor is the tight money supply situation, the source said.
Money supply however may be increased by CBSL subscribing to T Bills, but that may create further inflationary pressure on the economy.
However a source said that demand side inflationary pressure on the economy is subdued.
Also, continued easing of monetary policy which translates to credit made available cheap may also lead to a BoP crisis like what happened two years ago as the Sri Lankan economy runs a trade deficit.
The rumour is that there may be no more policy rate cuts for the next three months after last month’s 50 bps scaling down of policy rates, a market source said.
Further easing of monetary policy which translates to credit made available cheap may lead to a BoP crisis like what happened two years ago as the Sri Lankan economy runs a trade deficit.
But a tight liquidity situation may be a disincentive to borrowings due to borrowings becoming expensive. That in turn will impact investments, higher earnings and the creation of employment opportunities, whilst slowing down growth.
Meanwhile a CBSL source alleged that inflation measurement which is in the domain of the Census and Statistics Department (CSD) had obtained the advice of an IMF consultant to help it to improve its reporting standards.
Some 373 items go to make the inflation basket, he said. But apparently what those 373 items are, are allegedly not divulged to the public.
CSD wants to make inflation measurement, which is currently confined to Colombo, islandwide, the source further said.