Though Sri Lanka badly needs higher levels of investment, to boost growth and reduce poverty, economists are warning that chronic macro-economic instability is hindering progress, with the deteriorating security situation also adding to the country’s woes. An appreciation of the real effective exchange rates, caused by adverse inflation differentials will eventually hurt domestic producers.
High inflation and macro-economic instability not only causes widespread poverty but also discourages investment, because it makes in difficult for businesses to operate.
A World Bank study found that, urban firms listed macro-economic instability as the third biggest constraint for doing business, after high electricity tariffs and policy uncertainty.
The fourth reason was high interest rates, which is usually a result tight monetary policy compensating for fiscal profligacy.
But in 2004, Sri Lanka’s interest rates went sharply negative in real terms, as Central Bank eased monetary policy in the face of expansionary fiscal policy, and an emerging exchange rate crisis, while financial market players watched in awed disbelief.
As a result, the bond markets in particular, had to anticipate future interest rates based on the