Sri Lanka’s Central Bank last week reduced policy interest rates as much as 50 basis points to spur growth. The Central Bank wants to make cheap money available to people to spend instead of saving, so that it will fuel economic growth. This is not a policy road the country has not travelled earlier. Every time we went on this road, along with the expected economic growth, a visible outflow of money from the country took place, pressurising Sri Lanka’s Balance of Payment position and foreign reserves.
It will be interesting to analyse the mindset of the authorities who resorted to a policy rate cut at this juncture, despite the warnings signalled by the International Monetary Fund (IMF) which came to Sri Lanka’s rescue a few years back with a US $ 2.6 billion Stand-by-Facility, after a loose monetary policy regime that diminished the country’s foreign reserves.
It seems that the authorities feel that they want to show growth numbers to people and to the world. If they are planning to harp on the growth numbers, a sustainable, long term oriented growth would not suffice. If they feel that Sri Lanka’s economy didn’t grow as expected
from a country that came out from a nearly 30-year old war, instead of playing with the country’s monetary policy, they should try to identify where we have gone wrong and why foreign investments have not been coming to the country as anticipated.
The dangerous aspect about Sri Lanka adopting a loose monetary policy is the want of manufacturing goods locally and the notorious habit of Sri Lankans importing consumer items which include motor vehicles. This will create an outflow of money from Sri Lanka and it will be further increased with having to payhigher fuel bills. This happened last time when the country loosened its monetary policy.
Meanwhile, the authorities decided to cut interest rates at a time when Sri Lanka is experiencing a reduction in export earnings. In 2012, earnings from exports contracted by 7.4 per cent, and have continued to contract by 8.1 per cent in the first quarter of 2013.
The drying up of revenue sources will push the authorities to resort to various creative measures amid a loose monetary policy environment such as a temporary reduction in motor vehicle import duties etc. which could deteriorate the long term economic growth of the country. This shows that the availability of cheap money will fuel the growth of other countries and not ours due to high imports.
On the other hand a loose monetary policy will further fuel inflation, which is expected to go up with the recent electricity tariff hike.
The website of the Central Bank mentions as its objectives is to maintain economic and price stability in the country. The word stability is really important and present evidences contradict the Central Bank’s ability to achieve economic and price stability through a loose monetary policy.