Financial Times

Central Bank says inflation on the rise
The Central Bank said its Monetary Board has decided to maintain policy interest rates unchanged at their current levels despite an upward trend in inflation and an expansion of broad money supply driven by higher than expected growth in credit.

"The Monetary Board decided to keep its policy rates unchanged at current levels, i.e., the Repo rate at 7.00 per cent and the Reverse Repo rate at 8.50 per cent, at the Board meeting held on 12 October 2004," a bank statement said.

The following are excerpts from the statement:
Economic growth in the second quarter of 2004 reached 5.2 per cent showing a continuation of the high growth momentum that began in the second half of 2002, although there was some moderation in the rate of growth compared with the first quarter. Accordingly, the growth in the first half of the year was 5.7 per cent, which was marginally higher than the 5.6 per cent recorded in the first half of 2003.

Rising international and domestic demand supported the output growth in the industrial sector, while the construction and associated sectors also recorded a healthy growth. The services sector, which accounts for over half of the GDP, continued to grow with the increase in port related activities, telecommunication industry and an encouraging improvement in tourism.

The growth momentum in these sectors is likely to continue during the rest of the year, but with some downside impact from the drought and high oil prices. Given these developments, the overall growth for the year is likely to be in the range of 5 - 5.5 per cent. In 2005, growth is expected to be higher and more broad- based, with necessary policy adjustments along with expected normal weather conditions.

As expected at the beginning of the year, inflation, which recorded a downward trend from 2002 till end 2003, is now on a rising trend. Inflation as measured by the point-to-point change of the Colombo Consumers' Price Index (CCPI), has increased at a faster rate from a 0.5 per cent in January 2004 to 11.6 per cent in September 2004.

The 12-month moving average change of the CCPI, which was on a declining trend, reached its lowest level of 3.7 per cent in April 2004, and has risen to 5.4 per cent by September 2004. Current indications are that inflation as measured by the Colombo Consumers' Price Index (CCPI), would be around 6-7 per cent by end 2004, somewhat higher than the original expectations.

The higher inflation is mainly due to the negative impact of the drought on agricultural production, the revision of fuel and transport prices and high import prices of essential commodities such as wheat flour, sugar and milk powder.

On the external front, exports grew by 8.4 per cent (in US dollar terms) while imports grew by 19 per cent during the first seven months of 2004. The trade deficit continued to widen during the first seven months of 2004, increasing to US dollars 1,285 million from US dollars 824 million in the first seven months of 2003.

The services account and transfers recorded surpluses of US dollars 163 million and US dollars 651 million, respectively, but the current account deficit expanded due to the sharp rise in the trade account deficit. The current account deficit has widened to US dollars 429 million during the first six months from US dollars 2 million recorded during the corresponding period in 2003. The performance of net inflows to the capital and financial accounts has been mixed with a marginal increase in the capital account and a reduction in inflows to the financial account, resulting in an overall BOP deficit of about US dollars 250 million for the first seven months of 2004.

These developments caused a decrease in the country's reserves from US dollars 3,218 million in December 2003 to US dollars 3,162 million in July 2004. The gross official reserves decreased from US dollars 2,329 million in December 2003 to US dollars 2,069 million in August 2004.

The rupee has depreciated against the US dollar at a relatively faster rate so far in 2004, a depreciation of 6.7 per cent. During this period, the rupee also depreciated against the sterling pound (7.7 per cent), the Japanese yen (3.2 per cent), euro (4.8 per cent) and the Indian rupee (6.0 per cent). Reflecting these currency movements, the 24 currency nominal effective exchange rate (NEER, 1999=100) depreciated by 6.0 per cent, while the 24 currency real effective exchange rate (REER, 1999=100) depreciated by 2.1 per cent by end September 2004.

The inter-bank market rates remained stable around 8.00 per cent during the last two months. The yield rates of government securities shifted down during this period. However, the Average Weighted Deposit Rate (AWDR) increased from 4.98 per cent in August to 5.22 per cent in September. The Average Weighted Prime Lending Rate (AWPR) declined from 9.72 per cent in August to 9.60 per cent in September 2004.

Monetary aggregates have expanded at a faster rate than anticipated. The expansion of broad money supply (M2b) of 17.5 per cent in August 2004 was mainly driven by the higher than expected growth in credit to both private and public sectors.

Private sector credit growth was 21 per cent in August 2004 on a point-to-point basis. The expansion of credit has been supporting the growth momentum in the economy since a large part of the increase is for commercial and investment purposes.

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