Nearly two months into a policy rate cut in May, the Central Bank Governor, Ajith Nivard Cabraal has signaled again another round of monetary easing in September or October, a decision that appears to be dependent on inflation expectations.
“If we feel very confident with the events of the next few months, then we would feel a little more inclined to relax further,” Cabraal was quoted as saying to The Wall Street Journal this Monday.
If the Central Bank cuts key policy rates as it says, it would be the third round of monetary easing within a matter of 9 months.
Following the policy easing that began last December, cutting 25 basis points, the Central Bank again lowered the rates by 50 basis points in May, leaving the repo rate at 7.00 percent and reverse repo rate at 9.00 percent.
According to analysts, Monday’s statement by the Central Bank Chief will again bring uncertainty about future rate cuts and therefore speculation is likely to lead the financial markets as the higher than expected rate cut in May, which signaled a stable policy-rate environment for the remainder of the year.
“It appears that the Governor has again gone back on his words where he justified the higher than expected rate cut in May was to ‘reduce uncertainty in the market’ over future cuts,” an analyst said on the grounds of anonymity.
Meanwhile, an ex-Deputy Governor of the Central Bank, Dr. W.A Wijewardena recently forewarned of the consequences of further monetary easing.
He noted that in a relaxed monetary policy environment, the cheaper credit will be mostly absorbed by the consumptionrelated imports in an open economy such as Sri Lanka, leading to Balance of Payment (BoP) problems.
As he further explained, the resultant BoP deficit then will have to be financed with foreign reserves. Once all the foreign reserves are exhausted, with no more left to defend the rupee, the country will have to allow the rupee to go for a free-fall.
Therefore he believes the relaxation of the monetary policy to stimulate the economy in a background of cost increases will surely invite inflation.
Meanwhile, NDB Stockbrokers also cautioned that aggressive policy rate cut in May followed by the reduction of the Statutory Reserve Requirement (SRR) by the commercial banking system may insert inflationary pressure and push headline inflation beyond 10 percent over the next 12 months.