New CBSL Act – Monetary Policy – Interest Rates Et Al.

By Rusiripala Tennakoon –

The country has received the First Monetary Policy Review of the Monetary policy Board under the new Central Bank of Sri Lanka Act No 16 of 2023. This Act was to provide for the establishment of the Central Bank of SriLanka; for the repeal of the Monetary law Act (chapter 422); and to provide for matters connected therewith  or incidental thereto.

As this is the maiden policy review meeting under the new Act let us take a look at the high hopes projected by the Governor CBSL and announced by him at various public Economic Forums in explaining the important objectives soon after its enactment.

I wish to high light a few of those;

* The new Central Bank Act enables welcome separation and good coordination between the Fiscal Policy and the Monetary Policy;

* Ending of a period of dominancy of the Fiscal policy over the Monetary policy enabling the creating of a more balanced and positive impact on all sectors of the economy;

* “The new Central Bank Act which was passed in parliament recently will ensure the Central Bank’s mandate to maintain domestic price stability, financial stability and greater accountability to the general public of the country thanks to the provisions that establish the independence of the Central Bank.

* According to its provisions, whatever we do, we are accountable to the public, to the parliament and to the Cabinet.

* The new law empowers the Central Bank to implement flexible inflation targeting. And that framework will stay on course irrespective of the administration in power or whoever happens to be on the Monetary Board of the Central Bank. This will ensure predictability and stability of the monetary policy framework.

During his review process he also pinpointed the following cardinal factors underlying the new enactment.

* It will end the fiscal dominance on Monetary Policy,

* The former provision for the Secretary to the Treasury to sit on the Monetary Board which created a conflict of interest to reduce the borrowing costs for the Govt. and his interest to reduce the cost of financing will be no more with the moving out of the ST from the MB

* The need for the money-printing to facilitate Fiscal policy and government spending is now stopped

* The appointment as members of the MB to ensure their suitability under the new Law provides for the Constitutional council to approve the names recommended by the Minister of Finance

The Governor, in short, endorsing and hailing the new Act confirmed concluding that new Act will consolidate the independence of the Central Bank, which he presumed would be, a favourable outcome for all sectors of the economy.

However, a remark made by him about the parliamentary debate over the Draft Bill appears to be more a whimsical sensibility than a provocative reference when he stated “On the whole, it was a good debate although it was obvious that some members of parliament who took part in it, had not read the bill’s provisions”.

It is not our intention to find fault of the references made by the Governor but to subject the developments we are now experiencing under this proposed panacea in response to IMF specialist medication recommended for administration by our House Officers and physicians.

Hence with these enlightening and encouraging view points expressed, we will attempt to take a look at the hard truths encircling us and the current scenario of the related affairs.

It is best to confine our observations to the latest PRESS RELEASE of the CBSL on 5^th October 2023. The very first announcement is the decision of the MB to reduce Policy rates; viz. the Standing Deposit Facility Rate (SDFR) and the Standing Lending Facility Rate (SLFR). Both these policy rates are of immense importance to our ailing economy striving to emerge from its’ long- standing stagnant bog, under the new lease of life given to the CBSL, through the New Act which empowers the MB to implement flexible inflation targeting and thereby make the economic framework to  stay on course irrespective of the administration in power or whoever happens to be on the Monetary Board of the Central Bank, to ensure predictability and stability of the monetary policy framework! The release states that the MB has taken this decision after a careful analysis of the current and expected developments. According to the Press release they have addressed the low inflation and the benign inflation expectations in the domestic economy.

The Primary object of the Central bank shall be to achieve and maintain domestic price stability and to secure the financial SYSTEM STABILITY. It has to determine and implement monetary policy and the Exchange rate policy. Therefore, it can be presumed that the fixing of inflation targets is addressed taking these factors into consideration.

Forecasting Inflation is no doubt an extremely challenging exercise for the policy makers and market participants.There are several theories and practices that prevail(dealing with the subject)in the forecasting exercise to determine what is driving inflation. The uncertainties experienced during the Pandemic period and its aftermath made things more difficultin focusing on the factors that contribute to inflation.

The fairly large percentage of consumption categories with the largest price increases account for a significant percent of overall population. There are several other factors that play a vital role as potential drivers of inflation. Maneuvered Interest Rates, Money Supply and even the increases and decreases in the Labour market are among those. Even the Stock Market movements can be taken into account for the Inflation expectations.

It is difficult for economic forecasters to conclusively determine how these factors could influence future inflation. So, in can be concluded that adjustment of monetary policy is one of the important measuresto stabilize inflationary trends. In this context a cursory glance at the prevailing price structures that affect the masses may give us a different picture about the realities.

According to the department of census and statistics; Sri Lanka’s key inflation rate slowed to an eight-year low of 1.3% in September 2023, down from 4% in the previous month, primarily attributed to ongoing reduction in food inflation (-5.2% vs -4.8% in August) as well as slowdowns in prices of non-food items (4.7% vs 8.7%). On a monthly basis, consumer prices rose by 0.9%, rebounding from a marginal decline (-0.02%) in August. 

In Sri Lanka, the Consumer Price Index (CPI) is composed of two main groups: Food Items (41%) and Non-food Items (59%). Food items are mainly composed of: Bread & Cereals (8%), Fish & Sea food (6%) and Vegetables (6%). The most important Non-Food Items are: Housing, Water, Electricity, Gas & Other Fuels (24%), Transport (12%), and Restaurants & Hotels (6%).

Let us look at the consumer prices prevailing in the normal market place patronized by the ordinary folk (ie. by the largest percentage of the population) to find out the realistic living cost and the prices.

Lowest quality edible rice sold by the CWE is Rs 145 /= per KG

A loaf of bread has a spread between Rs 170- 200 

Coconut prices have stabilized around Rs 100 per nut

Chillies, Onions and lime (essential ingredients in the Pol Sambol) prices have soared to high levels

An ordinary family with limited income (sometimes no income other than the free grant given by the Govt,) will have no choice other than opting for a rice meal (which is our staple food) and the cheapest accompaniment, the Pol Sambol (which is a delicacy of the elite),in place of bread eaten in between more frequently. The composition of the Food Items in the meal basket of the poor and lower middle class cannot expand beyond this mix up in a realistic assessment.

WE do not need any expertise to compare these prices with the prices before the crisis onset. They have virtually doubled.

Accordingly, whatever the statistical equations used are, an average person has to live a miserable life aggravated by unemployment, poor health facilitation,(hardly supported under medical assistance) and several other factors.

The Non-Food items in the govt. statistics basket too are rapidly changing more often upward than any reductions.The cost of essentials such as Water, Electricity, Gas, Kerosene and fuels for Transport are all very high and always subject to price hikes.

The CBSL is envisaging a medium term 5% inflation to stabilizein such circumstances under the autonomy &independence they have got freeing from political influence.

No comments other than stating the fact that inflationary trends are projected contemplations, and are highly hypothetical often ending up with erroneous results. We wish all the best to the CBSL efforts to achieve their projected stabilization (an inflation rate at 5% level). We will stay with our fingers crossed to see how the accountability entrusted to the CBSL under the independent act will be examined by the very Parliament which passed the new Act by parliamentarians including some who appeared to have not even read the Draft!

Going further through the Press Release we see other high expectations of the CBSL resulting from the reduction of policy interest rates as what is indicated below.

They expect the Licensed banks to reduce interest rates. For sure the Commercial banks will have no hesitation IN REDUCING THE INTEREST RATES offered by them to the depositors. We can expect an overnight reduction of these rates. In order to avoid inter- bank competition, the LCBs will be careful enough to engage in this exercise to effect the changes in consultation among them.

The depositors who lived on the interest incomes from their savings of the terminal benefits will hit the ceiling when the LCBs announce the new FD rates to be offered under this SDFR rate change. To date we have not seen any specific direction issued by the CBSL to the LCBs to prevent this and safeguard this vulnerable section of the society.

The cap that provided some solace to the retirees assuring a fair rate of return for their deposits is no more. They have been thrown to the wolf like.

Let us see how the expectation of the CBSL for the Financial sector to pass on the benefits of the reduction of Lending Rates to the individual and businesses adequately and swiftly to support the envisaged rebound of the economy.

A phenomenon we are experiencing is that our policy packages give more weightage to inflation targeting as a key factor in the monetary policyin the context of price stabilization, more than the emphasis on growth and employment objectives. The uninterrupted and smooth flow of funds in particular to the small and medium industry sector is extremely important to reactivate the strangled SMI sector. At the village level there are many productions oriented small scale operations in this category in need of fresh capital inducement to restart their activities now defunct. Resulting loss to the economy by way of slowed production and employment is high at the village level.

These sectors remain handicapped due to the high cost of loan funding through the commercial bank network, which they claim as prohibitive in the current context. Lowering of the SLFR will help alleviating this hardship only if the LCBs offer a meaningful rate reduction in their lending operations.

Unfortunately the response of the LCBs to the lowering of policy rates by the CBSL in the recent pasthas not seeped down tothese lower levels since the banks are holding onto high interest margins they used to apply. Mere expectations of the CBSL, for the LCBs to effectively provide concessional rates to make the economy move forward will not deliver any meaningful result unless specific instructions are given to that effect. CBSL can use the regulatory and supervisory authority they have to design schemes under which the LCBs could provide loaning facilities to identified sectors contributing to Production and Growth. Fixing predetermined Caps for directed lending will take care of this need.

The SMI sector will be a significant contributor to the economic rebounding process that the central bank has envisaged under the proposed Policy Rate Adjustment.

It is noteworthy that on two recent previous occasions, the lowering of the Structural Deposit Ratio of the LCBs and the lowering of Policy Rates these benefits did not flow down to revive the economy as expected.

But certain affluent sectors dealing with Bond Markets and intermediating Primary Bond Dealers, however have made a fortune in their business operations with the Policy Rate Reductions introduced.

Decisions of the Central Bank should contribute to a fair income distribution as the bottom line of their policies in addition to the superficial expectations announced.

In concluding it is necessary to stress as an urgent step there is need for “a strong dose of Public and Central bank regulations and supervision of the Financial system …”

Some degree of this application to the private capitalism may not be out of place.

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