Sri Lanka’s Central Bank is now to be under immense pressure to jack up the policy rates as early as this week as the economy appears to be facing another balance of payment (BoP) crisis in less than a year since it averted one with the help of the International Monetary Fund (IMF) last year.
The Monetary Board is meeting later this week to decide on the rates for the second time this year with a challenging task of taming a monetary base, which is rising at an accelerated pace, rising inflation, dwindling reserves amid continuous foreign outflows and a weakening rupee.
Meanwhile, the 25 basis point hike by the US Federal Reserve last week and further hikes pencilled for this year have also posed fresh challenges to Sri Lanka’s Central Bank to keep its foreign holdings in government securities in tact because further erosion could be deadly.
“Given this scenario, Sri Lanka cannot remain oblivious to the US monetary policy tightening. If Sri Lanka does not follow suit, the remaining foreign investments in government securities by foreigners amounting to US $ 1.2 billion might also fly out of the country.
That would be fatal to Sri Lanka’s exchange rate,” said Dr. W.A. Wijewardena, a respected economist and a former Central Bank Deputy Governor, in his weekly column yesterday in our sister newspaper, Daily FT.
Foreign holdings in Sri Lanka’s government securities have been falling from its peak of US $ 3.5 billion in February 2015. This accounted for half of Sri Lanka’s gross official reserves of US $ 7.2 billion then.
“Thus, at the moment, Sri Lanka has not been left with an alternative, but to tighten monetary policy by way of an increase in Central Bank’s policy interest rates,” Dr. Wijewardena added.
But by the end of February 2017, the foreign reserves had dwindled to record lows of US $ 4.8 billion while foreign debt obligations due during the next 12 months have risen to US $ 4.8 billion. The rupee has also has further weakened—the symptoms of a classic BoP crisis.
It was only last week Dr. Nimal Sanderatne, a former Central Banker and a senior economist in the country said the country is in a BoP crisis with low foreign exchange reserves.
“The chaotic political environment, policy uncertainty and inept implementation are underlying causes for the balance of payments crisis,” Sanderatne said in his weekly column in our sister paper, The Sunday Times.
Several other economists Mirror Business spoke to were of the view that another rate hike is imminent.
“A March rate hike is very much on the table,” an economist said requesting anonymity.
However, a minority of analysts Mirror Business spoke to are of the view that the Central Bank may hold the rates as credit disbursements had abated in January and February and the recent high inflation was mainly due to supply concerns stemming from the prolonged drought.
The headline inflation, according to national prices in January 2017, spiked to 6.5 percent year-on-year from 4.2 percent in December.
The coming festive season generally lifts the price levels further up due to the demand side pressure. The International Monetary Fund (IMF) last week asked the Central Bank to stand ready to tighten the monetary policy unless the credit and inflation show signs of slowing down.
However, there is no doubt that when deciding the direction of the policy rates this Friday, the Monetary Board faces the daunting task of striking a balance between averting a BoP crisis and maintaining a growth level at a leave above 5.0 percent.