By J. Lorenz
May 19, 2017 (LBO) – The building blocks necessary for sustainable growth over the next 10-15 years and overall macro-economic growth have been put in place, the governor of Sri Lanka’s Central Bank said.
Speaking to the foreign correspondents’ association, Governor Indrajit Coomaraswamy discussed the three frameworks of macro-economic fundamentals, which are fiscal adjustment to lower the budget deficit, a flexible inflation targeting regime and managing exchange rates to bring the Real Effective Exchange Rate (REER) down to 100 gradually, with the hope of maintaining competitiveness of the economy.
While the growth rate for last year was 4.4%, CBSL’s growth outlook for 2017 is 5% provided there is rain fall, while ADB and World Bank’s outlook for 2017 is 4.5%-4.8%.
The drought last year affected agricultural activities and the sector recorded a negative growth of 4.2% in the past year and there was significant fiscal consolidation which is critical to create the above mentioned building blocks.
It is normal for growth to get affected due to stabilization processes but we need to get away from past practices of artificial highs, stated the governor.
Headline inflation is 4%-6% but this is temporary. “It is not due to underlying demand side pressure in the economy,” emphasized the governor.
The factors that have contributed to the prevailing inflation rate is the very low inflation in the 1st Quarter of 2016 as a result of imported deflationary effects associated with low international commodity prices, the VAT Adjustments, drought and the depreciation in the currency, but none of these are sensitive to interest rates.
Inflation will decrease due to the base effects of the 1st quarter deflation, the VAT adjustment easing off and if there is a decent Yala season. Inflation is expected to be 5% by end 2017 as per CBSL models.
CBSL remains cautious about increasing interest rates. The policy rates were increased only as a signaling mechanism to keep inflation within the targeted band. Overall credit growth was 18% while the expectation was 15%, but private sector credit growth was 21.9% for 2016, mainly due to the 2 state banks (People’s Bank and Bank of Ceylon) switching from lending to SOE’s to lending to the private sector.
BOP and Reserves
The Balance of Payments deteriorated further mainly due to the drought as Sri Lanka had more oil imports and reliance on thermal generation, as well as a higher quantity of imported food.
There was a significant outflow of capital from government securities after the US election but there is a reserve build-up with the recently concluded sovereign bond issue of US$ 1.5 Bn and the syndicated loan of US$ 450 Mn expected in the next few weeks.
CBSL targets to purchase US$ 1.2Bn from the market and divest some assets to realize around US$300-500Mn. The projected reserves for end 2017 is US$ 7.2Bn
Changing Debt Dynamics
Allowing tradable goods to fall as a percentage of GDP was a major set-back for Sri Lanka. In order to change the debt dynamic, tradable goods needs to be increased and the trading environment needs to be improved.
It is difficult to change the debt dynamic unless our export performance increases and FDIs are critical for export development. Further, the export basket needs to be more complex and diversified as Sri Lanka cannot compete with a basic basket of exports with low cost countries such as Bangladesh and Vietnam. The challenge is in identifying the goods for the export basket and the BOI is working on this.
The Critical factor in negotiating FTAs is to protect our interest, the governor said. There should be special and preferential treatment, safeguards and non-reciprocity when negotiating FTAs. Being in a strategic location in the Indian Ocean along China’s silk route, we need to promote ourselves as a hub in the region to attract FDI’s.
Having trade agreements with China, India, Pakistan, Europe and Singapore gives us preferential access to a market of 3Bn people which is our USP.
We cannot look at deals in themselves. The Hambantota Port deal is a catalyst for much more, as it has the potential to develop areas such as Uva Province, which has been let down by the government for 69 years.
Japan, India and Singapore are working together to create a master plan for Trincomalee which will have development affects across Rajarata with highways from Colombo to Kandy and the Kurunegala highway, he added.