Leading economists said this week they feel the Central Bank (CB) will not be able to address enormous challenges facing the economy through monetary instruments.
The CB is due to unveil its monetary and financial sector policies for 2009 and beyond (Road Map) on January 2, 2009. In spite of the rising fiscal deficit and declining reserves, the CB announced that the country is estimated to grow by around 6% in 2008, having recorded an economic growth of 6.3% for the third quarter. In its Monetary Policy Review for December 2008, the CB said the significant decline in inflation is attributable to the pass-through of the rapidly declining international commodity prices, the stringent demand management policies adopted by the CB and improvements in domestic supply conditions.
According to the CB, the US dollar-rupee exchange rate is stabilizing as a major part of short-term capital flows by way of Treasury bills and bonds have already flowed out of the country and the large stock of oil bills for imports at high petroleum prices have already been settled. The government is also exploring ways of raising external finances from alternative sources.
The CB further stated that the sharp deceleration in the monetary aggregates, together with recent favourable developments in relation to international commodity prices are expected to bring down inflation at a rate faster than previously expected. A veteran economist, who declined to be named, said the real challenge in the coming year is the impact of the fiscal deficit on inflation. The CB attributed the decline in inflation to its tight monetary policy but many economists say the real reason has been international factors.
Expenditure is most likely to overshoot and the fiscal deficit is also likely to increase unless inflationary pressures are corrected with monetary policies although economists feel the magnitude involved is such that the ability of the CB to control these issues through monetary policies is limited.
There is also an internal recession in Sri Lanka and given these recessionary conditions, a tight monetary policy is not appropriate and will aggravate the situation, a point which has been recognized by the CB which brought down its statutory reserve requirement. In essence, the CB is actually loosening monetary policy.
Another problem is that official reserves have come down due to the repayment of several loans that have come due. With reserves coming down coupled with the large trade deficit, managing the exchange rate will be another challenge. However in order to boost industrial exports, the currency has to be depreciated but this will imply another wave of inflation. If the currency is not depreciated, then the trade balance gets affected which puts another strain on the exchange rate. The problem for the CB is how they will handle a situation where they do not want to depreciate the currency which is needed from the point of view of the external sector.
The economist said the CB cannot be wholly blamed because it is difficult to use monetary instruments in alleviating the magnitude of the problems that have been created over the years. He did say that CB statements which intimate that economic conditions are favourable is simply the politicization of the CB.
He said the only hope for the country is if the war comes to an end and if some durable solution is implemented. It won't mean that defense expenditure will come down too much but there will be incentives to get foreign investment and help boost the tourism industry. Moreover, sectors of the economy such as fisheries can increase productivity. There might be increase in paddy and agriculture in the east and increased aid flowing in.
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