Dec 31, 2012 (LBO) – Sri Lanka’s stocks closed up 0.6 percent Monday, down 7.1 percent for the year, on top of an 8.5 percent loss in 2010, though the market has gained from mid 2012, brokers said. “This is the fastest adjustment period in our history,” Central Bank governor Nivard Cabraal said.
“So we can look that at the New Year with a lot of confidence.”
Sri Lanka raised interest rates and hiked energy prices in February 2012 after a sudden spike bank credit take to subsidize energy tariffs from mid 2011 generated balance of payments pressure.
After falling to 134 to the US dollar from 110, the rupee has appreciated to around 127 to the US dollar during the last week of December.
“This is close to the level of 125 that we expected,” Cabraal said.
Though Central Bank stopped rigidly target the exchange rate from February 2012 and allowed the forex market to respond to monetary policy, authorities have loosely signaled 125 to the US dollar as being a desirable rate for this year.
Inflation spiked to upper single digits with the currency depreciation in 2012, putting Central Bank’s record of keeping inflation around mid single digits under some strain.
The Central Bank also signaled and to its tightening cycle with a rate cut in December.
Market interest rates have started to fall faster than the rate cut and bank credit to private business is positive.
In previous crises, where rates have usually spiked to around 20 percent or more before state spending was brought under check and the currency floated, credit has sometimes turned negative, taking longer for investment to pick up.
The central bank is expecting economic growth to rebound to 7.5 percent of gross domestic product in 2013, from 6.7 percent in 2013.
Cabraal said Sri Lanka will end the year with a budget deficit of around 6.2 percent of gross domestic product partly helped by year end Central Bank profit transfers.
“The deficit will not go beyond 6.2 or 6.3 (percent of GDP),” he said.
The Central Bank profit transfers will also not have a damaging effect on inflation, the exchange rate or foreign reserves as the Central Bank had offset outstanding credit to government with the profits.
“We knocked off the T-bills with it,” Cabraal said.
A cash transfer of profits (printed money) to the state, when spent, increases demand in the economy pressuring inflation, pushing up imports, which in turn triggers a weakening of the exchange rate unless the Central Bank intervenes in the forex market.
Any intervention in forex markets then generates a foreign reserve loss. By off-setting Treasury bills in it stock, the cycle of negative effects had been avoided altogether.
“We will probably end the year with the neutral credit to government,” Cabraal said.
By December 28 the Central Bank’s Treasury bill stock was 176 billion rupees very close to the 167 billion at the end of 2012.
But the Central Bank also makes provisional advances to the Treasury – a type overdraft with printed money – which have accumulated over the years.