The International Monetary Fund (IMF) urged the authorities to closely watch the inflation and get ready for a rate hike as the long lag between the monetary policy actions and their effects in Sri Lanka could push the inflation up.
The IMF executive board concluding its routine Article IV consultation and second post-programme monitoring observes the signs of recovery in the private credit growth barring gold-backed loans and said, “The authorities should be ready to adjust rates as needed to ensure price stability—particularly given the long lags involved in monetary transmission.”
Sri Lanka’s headline inflation, which has been hovering on single digit levels for the last 65 months, fell to 2.8 percent in June 2014 year-on-year.
It was only recently that the leading stockbroking firm JB Securities forecasted the headline inflation to trend up to higher single digit levels, triggered by higher food inflation due to the ongoing drought.
Meanwhile, Standard Chartered Bank urged the Central Bank to keep its current monetary stance on hold as the latter might be mulling another round of easing to spur the credit growth, which fell to more than four-and-a-half-year low.
“Given the mix of signals, a cautious approach is warranted and the staff believes policy rates should remain on hold for the near term,” the IMF staff mission opined.
The staff mission further told that the current low inflation environment and the apparent change in inflation expectations offer an opportunity for a downward shift in the interest rate structure that might benefit the investment environment (and borrowing costs) over the medium term.
Meanwhile, the IMF also joined the group of critics of Sri Lanka’s unsustainable external borrowings.
While highlighting that Sri Lanka remains vulnerable to external shocks, the IMF urged caution with regards to external borrowing through the banking system.
“The Market Access Debt Sustainability Analysis (MAC-DSA) highlights the sensitivity of Sri Lanka’s debt sustainability to growth and foreign exchange shocks,” the IMF said.
Since last year, Sri Lanka has been accessing foreign capital markets through proxy borrowers but the state was cautioned by many quarters that those borrowings will also eventually fall under government debt, depending on the purpose of such debt is used for and government forex guarantees.
The IMF executive board in May 2013 cautioned the government over underwriting exchange risks of foreign currency borrowings by the banks as it could undermine the exchange rate flexibility, create contingent liabilities and also raise debt sustainability risks.
“Medium-term sustainability will depend on maintaining an outward orientation, diversification of the export structure and a judicious use of foreign borrowing—particularly given the rapid increase in debt servicing costs that have accompanied the shift from bilateral concessional debt to new loans on commercial terms,” the IMF noted.