CB needs to establish credibility, says Moody’s

Sri Lanka’s Central Bank will have to establish its credibility in terms of monetary policy effectiveness, with a special focus on inflation, according to international credit rating agency, Moody’s Investor Services. “What we look at is the effectiveness of the monetary policy and the Central Bank needs to establish its credibility facing an inflationary hike,” Moody’s Senior Vice President Marie Diron said in an interview with Mirror Business last week.

Despi te a 1. 5 percent statutory reserve ratio (SRR) hike in December 2015 and a 50-basis point policy rate hike in February, Sri Lanka’s private credit continues to remain high, hovering around a 20 to 25 percent range. The private credit in the economy in March grew by Rs.86.4 billion, climbing from Rs.53.7 billion in February and Rs.43.7 billion in January.

This is well above the Rs.58 billion average monthly private credit seen in 2015. On a year-on-year (YoY) basis, private credit grew 27.7 percent, accelerating from 26.5 percent a month ago. Diron said the value-added tax (VAT), which came into effect this May, would push inflation up and it’s likely that the Central Bank would “see through” it, a general practice among central banks towards VAT-led increase in inflation. “What would be much more negative is higher inflation could have an impact on wages. If that happens, increased inflation becomes more entrenched.” “(So) the Central Bank has to really re-establish its credibility focusing inflation,” Diron said. She also noted that US $ 1.5 billion International Monetary Fund (IMF) programme, which was approved for Sri Lanka, comes with an inflation targeting framework and it is yet to be seen how Sri Lanka would achieve it and how credible the process would be.

The other area to be tested would be foreign exchange rate intervention, according to Diron. Despite repeated calls by the IMF, the Central Bank still intervenes in the foreign exchange market, understandably as most of the government debt is in US dollars. “The new framework will be tested very quickly,” Drion quipped. Meanwhile, Moody’s is of the opinion that Sri Lanka’s deficit target of 3.5 percent by 2020 under the IMF programme is too ambitious.

“One of the risks is that, it will be difficult for the government to sustain fiscal tightening over a number of years,” she stressed. Also, the rating agency has revised down the country’s gross domestic product (GDP) growth forecast to 4 to 5 percent for the next few years from over 6 percent forecast in December 2015. Moody’s has been maintaining a B1 rating on Sri Lanka since 2010.