Lanka Business Online

Central Bank sees monetary policy stance as appropriate

central bank of sri lanka

Apr 18, 2016 (LBO) – Sri Lanka’s Central Bank, in response to an opinion column, states that its monetary policy stance holding interest rates unchanged on March 29 was appropriate.

WA Wijewardena, a former deputy governor, in an article in the Daily FT alleged that the Monetary Board should have tightened monetary policy “based on the logical economic choice which the Board would have made to lift the economy out of the prevailing foreign exchange crisis.”

But the Central Bank’s response is that it has tightened monetary policy, first by raising the Statutory Reserve Requirement (SRR) in January 2016, followed by increasing the main policy interest rates by 50 basis points in February 2016.

This was in addition to the “imposition of a loan to value (LTV) ratio on motor vehicle related credit facilities, the allowing of the exchange rate to depreciate, and the changes introduced to vehicle import duties,” during the last quarter, the statement said.

“The decision of the CBSL in March 2016 to maintain the monetary policy stance unchanged after two consecutive months of tightening is a logical step in allowing sufficient time for the market to respond to monetary policy actions while allowing room for the already increased market interest rates to stabilise.”

Crucially, the Central Bank believes interest rate tightening alone would be insufficient to address external sector pressures.

“In the midst of the balance of payments crisis in 2000/01, the CBSL unsuccessfully attempted to prevent the exchange rate from depreciating by raising policy interest rates. Specifically, the Reverse Repurchase rate of the CBSL was increased from 13.48 percent in June 2000 to 23 percent by January 2001.”

“In addition to the free-fall WA has discussed in his article, the end result was the disastrous growth outcome in 2001, where the country registered its only negative annual real GDP growth rate since independence.”

The CBSL is of the view that a blend of policy measures, including fiscal and monetary policy measures, is more appropriate, rather than solely relying on interest rates to correct the imbalances in the external sector.

In the meantime, the CBSL will continue to emphasise the need to implement necessary structural reforms to strengthen the fiscal and external sectors on a sustainable basis, it said.

This month, Sri Lanka may announce a support facility from the IMF after a decline in foreign reserves due to debt service payments and the supply of foreign exchange to cover foreign investor sales of government bonds.

A key factor is leading the market rather than following it, and the Central Bank’s decision to increase policy interest rates by 50 basis points in February 2016 surprised the market, the statement added.

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