Central Bank warns price adjustments are inevitable to keep budget on track

The Central Bank opted not to tinker with its short-term rates, but warned that holding back fuel price adjustments makes it difficult to balance the budget on an even keel. The Central Bank opted not to tinker with its short-term rates, but warned that holding back fuel price adjustments makes it difficult to balance the budget on an even keel. Despite eight year lows and pressure on the rupee, the overnight repurchase rate (repo rate) was kept at 7.00 percent and the reverse repurchase rate (reverse repo) at 8.50 percent, the bank said in a statement following its monthly Monetary Policy Meeting late Thursday.

But as the barrel of oil crosses the US$ 45.50 mark, the bank said authorities have to take a quick decision on how far they can continue to subsidise fuel prices.

“It would be difficult for the current monetary policy stance and the fiscal discipline, to which the government is committed, to be maintained, if adjustments are not made in the economy to reflect adverse developments that are taking place elsewhere, which have a bearing on Sri Lanka,” the bank said.

The bank commended authorities for allowing liquefied petroleum gas suppliers to pass on a price hike.

But prices for sensitive products like diesel and kerosene – largely consumed by the poor – should be raised ‘to reflect the current international prices’.

“It is not prudent for the budget to bear the cost of such subsidies as it amounts to sacrificing other essential public expenditure programmes. Faster adjustment will create greater resilience in the economy, enabling it to move along the long-term growth path.”

Therefore, all sectors of the economy would need to make quick adjustments to face prevailing conditions, the bank advised.

The higher oil bill is also telling on Sri Lanka’s inflation numbers.

The rate of inflation, which fell continuously from the second quarter of 2003, has started to pick up, as expected.

Inflation as measured by the 12 month moving average of the Colombo Consumers’ Price Index (CCPI) rose from 3.9 percent in June 2004 to 4.3 percent in July, while the point to point index increased from 6.8 percent in June to 8.9 percent in July.

“Inflation is expected to be around 6-7 percent at end year, based on the CCPI, about 1-2 percentage points higher than initially projected for 2004.”

While exports continued its healthy trajectory (up 9.5 percent), a heavy import bill has pushed the trade deficit to expand to US$ 894 mn from Jan-May, 2004.

The balance of payments will end in negative territory from Jan-June, though the bank is issuing over US$ 250 mn worth of two-year Sri Lanka Development Bonds to make up for the short fall in foreign aid.

The rupee has also come under lot of pressure, falling by 6.4 percent against the US dollar from Jan-July.

Despite inflationary pressures, a falling rupee has helped to maintain the country’s external competitiveness as reflected in the 24 currency real effective exchange rates, which has depreciated by 1.5 percent.

But the bank continued to dip into the foreign reserves to prop up the rupee.

Hence, gross official reserves have declined to US$ 2,104 mn (enough to cover 3.5 months of imports) at end June 2004 from US$ 2,329 mn (4.2 months of imports) at end December 2003.

Sri Lanka’s total reserves have slipped to US$ 3,130 mn (5.2 months of imports) at end June from US$ 3,218 mn (5.8 months of imports).

The interbank market remained liquid although excess liquidity declined, raising interest rates in the money market.

Interest rates along the government securities yield curve have risen during the month, with yield rates at the longer end seeing a sharper rise. The average weighted prime lending rate (AWPR) has risen slightly from 9.59 percent in June to 9.77 per cent in July.

Though a drought continues to trouble agro and plantation sectors, higher output from industrial and services sectors should keep year end growth at around 5.0-5.5 percent.

On the fiscal front, the bank said numbers for the first six months indicate a 4.2 percent increase in the budget deficit.

Following the same trend, the primary deficit increased to 1.1 percent of GDP from 0.4 per cent.

However, the current account deficit (government dis-savings) was maintained at 1.8 percent of GDP as in 2003.

The next regular statement on monetary policy is scheduled to be released on September 15.

-LBO Newsdesk: LBOEmail@vanguardlanka.com