Central Bank warns subsidies cant continue

The Central Bank of Sri Lanka expressed concern on State sponsored subsidies, but said overall growth remains on track, to ensure there need not be a change in short-term interest rates for September. The Central Bank of Sri Lanka expressed concern on State sponsored subsidies, but said overall growth remains on track, to ensure there need not be a change in short-term interest rates for September. The bank left its repurchase rate, at which it drains money from the banking system, at 7.0 percent, while the reverse repurchase rate stays at 8.50 percent for the 11 month. It reduced the rate by 2.75 percentage points in 2003 to the lowest since April 1997.

The bank said point-to-point growth in broad money (M2b) was 17.6 per cent in July, while reserve money expanded by 19 percent, to feed higher credit demand from the public and private sector.

The Monetary Board noted with concern the excessive growth in public sector credit, largely arising out of subsidies given on imported commodities such as petroleum products, wheat flour, and other related goods and services.

“The Board was of the view that the present concern can be addressed by phasing out subsidies, particularly by revising domestic petroleum prices in line with international prices and that such a move would support interest rate and exchange rate stability,” the statement said Wednesday.

Record-high oil prices, the new government’s decision to create jobs and promote agriculture are raising concerns inflation will accelerate and borrowing costs will rise, erasing economic recovery.

In August, the government opted to partly ease off on fuel subsidies, raising the prices of petrol and diesel. The move has stoked inflation, which topped 10.5 percent in August.

International prices of other major consumer good imports, such as wheat flour, sugar and milk powder have increased by 23 percent, 16 percent and 6 percent, respectively, so far in 2004.

If oil prices move up from its US$ 40 per barrel level and the drought continues, it will affect inflation and impact interest rates, the bank said.

Lower compensating inflows to the services, and capital and financial accounts have resulted in a deficit in the overall balance of payments. The bank expects the balance of payment deficit to touch US$ 200 mn by year end.

The developments in the external sector have increased the pressure and volatility in the foreign exchange market.

Although the Central Bank intervened in the foreign exchange market to reduce the excessive volatility in the exchange rate, the rupee fell 6.2 percent vis-à-vis the US dollar from Jan-Aug.

During this period, the rupee also depreciated against the Sterling pound (7 percent), the Japanese yen (3.9 percent), the euro (2.3 percent) and the Indian rupee (4.8 percent).

Sri Lanka’s reserves have also gradually eroded as the Central Bank periodically steps in to prop the rupee and repay foreign debt.

Gross official foreign reserves have declined from US$ 2,329 mn (equivalent to 4.2 months of imports) at end 2003 to US$ 1,953 mn (3.2 months of imports) at end July 2004.

Sri Lanka’s total reserve stock has fallen from US$ 3,218 mn (5.8 months of imports) to US$ 3,058 mn (5.0 months of imports) at end July 2004.

The average weighted call market rate rose from 7.59 per cent at end 2003 to a peak level of 8.71 per cent in July 2004, but has since stabilised at around 8.00 per cent at end August.

The bank said overall economic growth was on track to end at 5.0-5.5 percent. But a slowdown in the growth is expected as a prolonged drought hits agriculture output and electricity generation, while high oil prices effects other sectors of the economy.

The Central Bank will make its next monetary policy announcement on Wednesday October 13.

-LBO Newsdesk: LBOEmail@vanguardlanka.com