Continued monetary accommodation by SL a ‘dangerous strategy’ : Deutsche Bank report
View(s):The Sri Lankan Central Bank’s continued monetary accommodation, or the economic policy by which interest rates are kept low, is a “dangerous strategy and could sow the seeds for future potential imbalances”, according to a recently released report by Deutsche Bank.
It added that; “Most market participants however agreed during our discussions that Sri Lanka does not face any major imbalance risk, at least in 2014, but could face problems in the subsequent years, if the Central Bank authorities maintained substantial accommodation for a prolonged time”.
Titled “Sri Lanka: Economy on a stronger footing, but beware of policy error risks”, and published on January 16, the report however initially commented; “As per the official data, there is no doubt that Sri Lanka’s growth momentum has improved substantially through 2013, making it one of the fastest growing economies within Asia last year. There was a consensus that some improvement has indeed taken place in the real economy, but many market participants however raised doubt whether the economy was indeed growing at 8 per cent as the official data suggested”.
Further, it also emerged, to the writers of the report that “Central Bank authorities however assured us that they will remain vigilant on the inflation front and will act swiftly, if they felt inflation was becoming a bigger threat for the economy than growth at any stage. Most market participants and policymakers we talked to were confident that inflation would remain in mid-single digits during the 1H of 2014, barring any supply side shocks. We agree with this assessment, though we see inflation rising in 2H of the year to 7 to 8 per cent, led by demand side pressure. As monetary policy transmission works with a significant lag, we would expect the Central Bank to maintain an extended pause, and look to raise rates modestly from 4Q 2014, to prevent any significant overheating in the economy.
The risk is that, the Central Bank cuts rates further in the 1H of 2014, encouraged by a lower inflation print, which not only raises overheating risks, but also poses a threat for exchange rate stability”.
At the same time, the report also opined that there was a “consensus that the Sri Lankan authorities have shown significant resolve in bringing down the fiscal deficit below the 6 per cent of GDP mark, despite an unsupportive and hostile external environment and setbacks on the revenue front. We were assured that the headline fiscal deficit target of 5.2 per cent of GDP for 2014 will be achieved, at any cost”.
Additionally, it was also revealed that the “external position of the Sri Lankan economy remains comfortable at this juncture. Sri Lanka raised US$ 1 billion through a 5-year sovereign bond issuance last week (at 6 per cent yield), which has increased its gross official reserves to about $8.2 billion (sufficient to cover 5 months’ of imports). Based on our constructive view on the Balance of Payments, we expect the rupee to remain range-bound in 2014, with 130 likely to be the floor. Our discussion with various policymakers gave us the impression that the authorities are not in favour of allowing the rupee to appreciate too much from current levels, and if inflows do surge in the coming months, the Central Bank will use such opportunity to buy dollars and build reserves. In case of a sharp depreciation pressure, the Cenral Bank is expected to intervene, but only to smoothen intra-day volatility and not to change the direction of the exchange rate movement”.
(JH)