Apr 09, 2013 (LBO) – Sri Lanka’s interest rates and inflation would fall in the coming months in a virtuous cycle, helped also by market pricing energy which will lower credit pressure, Central Bank Governor Nivard Cabraal said.
Sri Lanka’s inflation rose 7.5 percent in the 12 months to March 2013 but eased from 9.2 percent in December, as the exchange rate fell from 110 to 134 to the US dollar in the first half of 2012 under pressure from sterilized foreign exchange sales.
Despite a cut in policy rates in December which raised some concerns about the credibility of central bank policy, lending rates have remained high, partly due to state borrowings from the banking system.
“The policy rates were revised last December,” Cabraal told reporters after releasing the bank’s annual report on the economy for 2012.
“We haven’t seen it happening as fast as we would like or with the intensity that it should have taken place. Even though the transmission is sometimes weak, we believe the trend is clear.”
Cabraal said falling inflation will also have a positive effect on interest rates.
“Hopefully that trend would continue into the next few months as well, which would give us a situation in the economy where the interest rates are in line with the inflationary tendencies also.
“As you know when inflation is due to come down in the next few months, so interest rates should also be moderating in the same manner.
Most of the inflation in 2012 – 6.99 percent – was generated between January and June 2012 when the rupee fell steeply. The rupee appreciated in the second half. The index gained only 2.05 percent in the second half of 2012.
In the first quarter of 2013, the consumer price index has so far gained 1.3 percent, and the rice faming lobby backed by elected rulers, are now raising a cry saying prices are too low.
When recovering from previous balance of payments crises, Sri Lanka had also experienced absolute falls in the index (deflation) as the currency continued to appreciate amid very slow or negative credit expansion.
Sri Lanka’s 2011 balance of payments crisis was mostly triggered by heavy bank borrowings by state energy entities to cover losses which were ultimately accommodated by the Central Bank through sterilized foreign exchange sales.
Cabraal said Sri Lanka had now seen 50 months of single digit inflation.
Treasury secretary P B Jayasundera said ongoing reforms in state energy pricing at Ceylon Electricity Board and Ceylon Petroleum Corporation will also help bring down credit growth and interest rates.
Sri Lanka’s previous period of low inflation from 2001 to 2003 was also achieved in the wake of a balance of payments crisis, where energy was market priced through a pricing formula.
“It will help in the long term,” Cabraal said. “Because we will see the banks not having to give further advances to those institutions, because they will be able to have a cashflow which is appropriate.
“So we expect the changes being made and CEB and petroleum corporation to stabilize the economy further. We expect that to be an important change that will occur this year.”
Cabraal said he expected the economy to grow by 7.5 percent this year after falling to 6.4 percent last year.