New CB chief sees strong growth, chances of lower rates

Reuters: A day after taking over as governor of the Central Bank of Sri Lanka, Arjuna Mahendran said interest rates can be reduced below current record lows once inflationary expectations flatten out, and called for an overhaul of the tax system to help businesses.
Mahendran was appointed by the new Government of President Maithripala Sirisena’s New Democratic Front, which won an election on 8 January, and has taken over an economy that is growing strongly, though fuelled by worrying levels of debt.
Sri Lanka’s economy has been growing over 6.5% under the previous Government since 2005 and has kept key policy interest rates at record low since January last year to spur growth.
Following Mahendran’s maiden policy meeting, the Central Bank opted to leave its policy interest rates unchanged, but the new governor was optimistic that inflation would ease and the economy would show a “robust performance” in the period ahead.
Economic growth was estimated at 7.8% last year, up from 7.3% in 2013, and Mahendran expected 2015 to be another strong year.
“I think we can easily maintain the stable 7.5% growth rate this year,” Mahendran told Reuters in an interview after January policy rate announcement on Tuesday.
Mahendran, an Oxford-educated graduate who has nearly 30 years of experience in the financial services industry across Asia, said the focus should be shifted to private investment and job creation and away from government spending.
“The Government had grabbed all the activities and as result, there is no space for private sector to grow,” he said, criticising the strategy of the previous Government, led by President Mahinda Rajapaksa.
He expected the new Government of Sirisena to exert more prudence. Finance Minister Ravi Karunanayake told Reuters on Monday that the new Government has inherited a “scary” economic situation, with large amounts of debt that has not been properly accounted for.
“The Government this year will practice very strong austerity. Then the whole government sector becomes manageable. Then the private sector will automatically grow.”
Mahendran said he advocated reducing the number of taxes from more than 20 to around five, and would pursue policies that would encourage private sector investments and create jobs.
“To me that is the main pillar,” Mahendran said. “You have to make taxes simple for the private sector, so that they can understand and pay easily and carry out their businesses. At the moment, they are trying spend more time to avoid taxes.”
Regarding monetary policy, the Central Bank is hopeful that inflation will moderate in the months ahead.
The Central Bank hopes last week’s fuel price cut and expected reductions in administered prices of some key commodities in the new government’s supplementary budget, due to be presented on Thursday, will help reduce inflation pressures.
Annual inflation jumped to 2.1% in January, after hitting a more than five-year low of 1.5% in December.
Waiting to cut
The Central Bank has targeted average annual inflation of 3% by the end of 2015. Average annual inflation in 2014 was 3.3%.
“You can’t cut interest rates suddenly because then the danger is inflation will take off again. Inflation expectations are still embedded in people’s mind,” Mahendran said.
“We have to keep rates stable for a while until those inflation expectations come down to a stable level and then we can cut interest rate further.”
With policy interest rates left unchanged for a 12th straight month, bank lending rates remained comfortably above the prevailing inflation rate.
The standing deposit facility rate, or repo rate – the rate paid to banks on funds deposited with the Central Bank – was held at 6.5%. And the standing lending facility rate was held at 8.0%.
Commercial banks’ average prime lending rate rose 10 basis points last week to 6.38%.
It has been below the Central Bank’s repo rate, because the Central Bank in September imposed a lower penalty repo rate of 5% for banks that use the standing deposit facility more than three times a month. The aim was to persuade them to lend more. Many analysts had expected the Central Bank to tighten policy by removing this lower penalty rate, but the Central Bank instead opted to keep it for now.