Sri Lanka’s interest rates should rise in coming months: economist

3 November 2015 03:13 am - 0     - {{hitsCtrl.values.hits}}

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Amid Finance Minister Ravi Karunanayake calling for 100 to 200 basis points cut in interest rates, a senior economist in the country cautioned against such a move and instead said the interest rates should be increased.

According to the Executive Director of the Institute of Policy Studies (IPS) – an economic think tank based in Colombo – Dr. Saman Kelegama, there is no room for further reduction in interest rates as the exchange rate is bearing a heavy burden.

“In my opinion, there is no room for a further reduction in the interest rates but the interest rates should go up in the coming months,” Dr. Kelegama told the recently concluded Sri Lanka Economic Association Annual Sessions.

Dr. Kelegama’s remarks echo the views expressed by ex-Central Bank Deputy Governor Dr. W.A. Wijewardene, who also warned against cutting interest rates.

“…reducing the interest rates at this juncture is similar to giving an additional sugar dose to a diabetic who already has high sugar levels in his blood,” Wijewardene said in a weekly column he writes for Daily FT.

Despite the decision to float the rupee, the pressure on the balance of payment continues to remain, as the adjustment in exchange rate did not complement with an upward revision in the interest rate.

Access to cheaper credit will not discourage imports—specially the likes of motor vehicles, despite the high cost of imports fuelling the import bill, which in return puts pressure on the balance of payments and the country’s external reserves. Unlike in other markets where depreciation pressure is largely handled by adjusting the exchange rate, Sri Lanka opted to sell its reserves in defence of the rupee.

“When an economy is adjusting, the exchange rate and the interest rate should together carry the burden of adjustment. So, if the exchange rate relaxation (which was implemented on September 4) is not complementing with an interest rate jacking up, then the whole burden of that pressure has to be borne by the exchange rate,” Dr. Kelegama explained.

Therefore, he said, the lower inflation alone cannot decide on the direction of the interest rates (monetary policy) but the overall macro-economic condition must be taken into consideration.

Sri Lanka in October ended three months of deflation to record a headline inflation of 1.7 percent year-on-year.
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