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Mon, 27 April 2015 13:03:37
Sri Lanka central bank suppressing interest rates: researcher
05 May, 2008 08:12:49
May 05, 2008 (LBO) – Sri Lanka's central bank is keeping interest rates suppressed and below the inflation rate to reduce government borrowing costs and maintain a high growth rate that presents a 'rosy' picture, a researcher says.
"Galloping inflation is also due to suppression of the interest rate by the government," says Muttukrishna Sarvananthan, principal researcher of the Point Pedro Institute of Development, Point Pedro, a think tank in northern Sri Lanka.

The reverse repo rate has been constant and had not changed since February 2007 despite rising inflation.

"Suppression of interest rate has meant that there is negative real interest rate in the market (i.e. the nominal interest rates have been lower than the rates of inflation)," he says in a paper on the economy of peace and conflict in Sri Lanka.

"Thus, negative real interest rate fuels borrowing by both the private sector and the government, which in turn leads to demand-pull inflation."

Sarvananthan says there are two reasons why the Central Bank is reluctant to increase the interest rate.

"One is to reduce the cost of borrowing to the government and the other is not to hamper economic growth.

"Interest rate rise would increase the cost of borrowing to the government as it relies heavily on domestic borrowings.

"Secondly, rising interest rate would also increase the cost of borrowing to the private sector and thereby reduce private investments, which in turn would decrease the economic growth rate.

Thus, Sarvananthan says, there has been a trade-off between economic growth and interest rate.

"The government has clearly opted to help growth rather than contain the rapid and sustained rise in cost of living. This is because growth rate gives a rosy picture of the state of the economy to the outside world (to potential foreign investors and lenders) and to the local people, whereas cost of living hurts only the local people (that too only the lower-middle class and below)."

Sarvananthan says the cost of living rises are easier to justify to local people in the current militarised politico economic context by attributing it as a necessary evil in order to combat terrorism.

The government is also trying to show that inflation is beyond the control of the government due to rising world market prices of fuel, wheat and milk powder.

But he notes that in the past couple of months prices of rice and coconuts have shot up enormously, which are entirely locally produced food items.

"Rice production has dropped considerably during the yala season last year, but coconut production was buoyant," Sarvananthan says.

"Therefore, blaming only the international markets for the cost of living rise is not tenable."

While it is true that some determinants of prices are beyond the control of the government, a lot more can be done by the government like increasing the interest rate to market rate to arrest galloping and sustained inflation.

"This financial repression partly explains the remarkable annual growth rate during 2007 in spite of a high intensity civil war," Sarvananthan says.

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