Article By: BiZnomics Research Team

USA Monetary Policy-Fed Dilemma

Federal Reserve Chair Jerome Powell mentioned that  US Monetary policy is “well positioned” to support the strong labor market, which is just now starting to benefit workers on the margins. He added that “the benefits of the long expansion are only now reaching many communities, and there is plenty of room to build on the impressive gains achieved so far,” a close look at the adjustments to employment data suggested the labor market may not have been as strong last year as previously thought, and thus we could once again witness a shift for lower interest rates. The September data released by the Bureau of Labor Statistics indicated a downward revision of the estimated job creation numbers. The agency said the economy added 170,000 jobs a month in the 12 months through March 2019, half a million fewer jobs than previously estimated. Powell in fact commenting on the job data numbers mentioned that “While this news did not dramatically alter our outlook, it pointed to an economy with somewhat less momentum than we had thought,”.

Germany Consumer Demand Shines

The mood among German consumers rose unexpectedly  heading into December, a survey showed this week that household spending will continue to prop up growth in Europe’s biggest economy at the end of the year. Record-high employment, inflation-busting pay hikes and historically low borrowing costs have turned household spending into a steady and reliable driver of growth in Germany, helping to cushion its export-dependent economy from trade problems. The consumer sentiment indicator, published by the Nuremberg-based GfK Institute and based on a survey of around 2,000 Germans, improved to 9.7 from 9.6 in November. A Reuter’s poll of analysts had predicted a stable reading. GfK said a subindex measuring economic expectations jumped as Germans became more optimistic about the growth outlook due to “tentative signs of easing” 

Australian economy continues to struggle

Wage growth in Australia looks to be stuck in the slow lane and it will take a sustained fall in unemployment to lift it to more economically desirable levels, a top central banker said on Tuesday. In a speech on employment and wages, Reserve Bank of Australia (RBA) Deputy Governor Guy Debelle said there was growing evidence that wage growth had become entrenched in a 2-3% range, down from the former 3-4% norm. This trend has been weighing on household incomes and spending, as well as dragging on the economy more broadly. “A gradual lift in wages growth would be a welcome development for the workforce and the economy,” said Debelle. “It is also needed for inflation to be sustainably within the 2–3% target range”. However, he held out little hope for acceleration any time soon, noting the bank’s liaison with firms showed 80% of companies expected steady wages growth and only 10% anticipated anything faster.” The more wages growth is entrenched in the 2s (2-3% range), the more likely it is that a sustained period of labour market tightness will be necessary to move away from that,” said Debelle. The central bank has cut interest rates three times since June, taking them to a record low of 0.75%, in part to try and drive unemployment down toward its goal of 4.5%.

China looks fragile

Oil prices slipped on Tuesday on concerns about economic growth and fuel demand as uncertainty remains about the ability of the United States and China, the world’s biggest oil users, to agree a preliminary deal to end their trade war. Brent crude futures were down 5 cents at $63.60, after rising 0.4% in the previous session. West Texas Intermediate crude futures fell 9 cents to $57.92, having risen 0.4% on Monday. Top trade negotiators from China and the United States held a phone call on Tuesday morning, China’s Commerce Ministry said, as the two sides try to hammer out a preliminary “phase one” deal in a trade war that has dragged on for 16 months.  “Oil traders remain hopeful a trade deal will get signed,” said Stephen Innes, chief Asia market strategist at AxiTrader. “Still, the lack of clarity around the tariff rollbacks, which is the key to economic growth and bullish for oil, continues to somewhat cloud sentiment. “China and the United States are “moving closer to agreeing” on a “phase one” trade deal, the Global Times – a tabloid run by the Chinese Communist Party’s official People’s Daily – reported earlier.

India Cuts Monetary Policy Rates for the six time

The Reserve Bank of India will cut interest rates in December for the sixth time this year, and again before July, according to economists in a Reuters poll which forecast those reductions would either marginally boost the economy or have no impact. Currently the most aggressive major central bank in the world, the RBI has cut rates by 135 basis points this year to 5.15%, but inflation has remained low by historical standards and policymakers have barely moved the needle on growth. The Indian economy expanded 5.0% in the April-June quarter on a year earlier, its slowest annual pace since 2013, and was expected to grow 4.7% last quarter, according to the latest Reuters poll, taken Nov. 20-25.That was significantly lower than the 5.6% rate predicted in the last poll, and would mark six consecutive quarters of slowing growth, a first since 2012.

It also comes despite a recent series of fiscal stimulus from Prime Minister Narendra Modi’s government, which was re-elected in a landslide in May. “Further rate cuts are likely to have a limited impact on the economy as cost of borrowing is not the pressing issue. The lack of risk appetite and fragile sentiment are holding back fresh investment in the economy,” said Sakshi Gupta, senior India economist at HDFC Bank. “While further interest rate cuts would support growth at the margin, we need to see a turnaround in sentiment to restart the investment cycle.

Cont..

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The Monetary Policy dilemma is nothing new as we have seen US, Japan and other developed economies question the monetary policy tools used to stimulate or contract the economic activity. The US president recently blamed the Federal Reserve Bank that its action of raising interest rates has slowed the US economy. A similar trend has also been seen in India in that the Reserve Bank has reduced its policy rate in the eye of national elections. The Reserve Bank of India Monterey policy cuts its benchmark repo rates to 6.25 percent citing slow economic growth and sharply lower inflation. The committee also change its monetary policy stance ‘Neutral” from the previous outlook of policy tightening. Monetary neutrality comes just a few months after Urjit Patel the former governor resigned amid widening differences with the government over various economic and regulatory issues including the government perception that monetary policy was too tight.

The new governor Shaktikantha Das said that after the announcement on the rate cut the slowing down in the economy and sharply lower inflation opened up for policy action. The need in his view is to stimulate private investment and consumption to address growth, given that the inflation target had been met. India’s inflation rate has been fallen from an annual average of about 10 percent to 3.6 percent in the 2018/2019 financial year. The phase of price increase is now below the target set in the reserve bank inflation targeting framework of 4 percent with a range of 2 – 6 percent plus or minus. In January Indian industrialists met the Governor of the Reserve Bank and appealed for a 50 percent rate cut and reduction in bank’s capital ratio to facilitate the flow of credit to industries to reduce their cost.

Sri Lanka Prime Minister has also appointed a committee to examine why banks have not reduced lending rates in spite of the fact that the Central Bank has reduced rates on two consequent sessions.

The recent announcements by Monetary Board of the Central Bank of Sri Lanka that the reduction of the Reserve Ratio on all deposits of commercial banks from 6 percent to 5 percent from March 1st 2019 following a reduction in the reserve ratio from 7.5 percent to 6 percent in mid-November 2018 comes in at a time when Sri Lanka is facing an daunting task to stimulate the economy given its below potential growth rate achieved over the past three years .Bank maintained their policy rates on deposits and lending facilities unchanged at 8 and 9 percent respectively on both occasions. The reduction in the reserve ratio in February 2019 is justified on the ground that some policy intervention by the Bank is warranted to address the large and persistent liquidity deficit in the money market although is natural on the change of policy rates.

Monetary Policy review by the Monetary Board in February and March have noted the following;

• The real economic growth remained subdued at 3.2 percent during 2018, compared to a growth of 3.4 percent in 2017. The growth of industry activities slowed down significantly to 0.9 per cent during 2018, mainly as a result of the contraction in construction.
• Real GDP growth will remain moderate in 2019 as well. The continued low growth emphasizes the need for implementing growth enhancing structural reforms expeditiously.
• The deficit in the trade account contracted with the continued growth of exports alongside a decline in imports in response to the policy measures to curtail non-essential imports. Increased tourist arrivals in the first quarter of 2019, improved earnings, although workers’ remittances moderated during the first two months of 2019.
• Proceeds from the issuance of the International Sovereign Bonds (ISB) helped increase gross official reserves to an estimated US dollar 7.6 billion by end March 2019.
• Noticeable growth of earnings from tourism continued to support the current account although worker remittances marginally declined in 2018.
• The recent uptick in inflation was driven by the upward revisions mainly to prices of fuel but inflation expectations indicate that it is likely to remain within the desired range of 4-6 percent in 2019 and beyond, with appropriate policy adjustments.
• Credit extended to the private sector decelerated to 13.6 percent during the first two months of 2019, from 15.9 percent in December 2018. broad money (M2b) also slowed down during the first two months to 14.4 percent in February 2019 from 13 percent in January 2018 of the year. A growth of around 13.5 percent is expected in private sector credit in 2019, while broad money (M2b) is expected to grow at around 12.0 percent in 2019.
• The Monetary Board views that broad money (M2b) growth is likely to support economic activity adequately without creating excessive demand driven inflationary pressures.
• The domestic money market has improved reflecting Call Money Rate declining by 45 basis points so far during 2019, however other market interest rates continued to remain at high levels thus far in 2019. The Central Bank may implement mechanisms for more effective downward adjustments in market interest rates.
• At present there is a slowdown in private sector credit. A Working Committee appointed on the directions of Prime Minister Ranil Wickremesinghe is expected to submit a report recommending necessary actions to reduce the private credit interest margin.

The Central Bank Governor Dr. Indrajit Coommaraswamy explained at the press conference in February 2019 that the policy intervention to inject LKR 60 bn was to ease liquidity shortage. This liquidity shortage continued to prevail despite the liquidity injection of LKR 90 bn in November 2018 through a reduction in reserve requirements. The Governor indicated that liquidity shortage in the market is around LKR 100 bn and expects that the market to find the balance in the shortfall of around LKR 40 bn. He also hinted that large liquidity injections could spill into more imports, thereby adversely affecting foreign reserves and the exchange rate. The governor’s view was that the lower interest rates encourage consumption related loans, with the public opting to import cars or to invest in construction industry that has a significant import content. The Governor’s dilemma is how growth could be fostered without undue pressure on external reserves.

International Reserves of Sri Lanka declined to USD 6.2 bn against predetermined short term (less than 1 year) liabilities which stood at USD 6.5 bn placing the Central Bank on a negative reserve position. The reserve position was USD 6.9 bn in December 2018, down from USD 07 bn in November 2018. The reserves are partly protected with 200 percent cash deposit margins on import of motor vehicles and 100 percent cash margins on consumer durables. These policy actions have substantially reduced imports in recent months. The test is whether the exchange rate will remain stabilized once these direct controls on imports are removed.

Source: Central Bank of Sri Lanka

As shown in the chart, nominal interest rates have moved steadily in an upward direction although the differences between them and the NCPI Core Inflation Rate have narrowed owing to a steep increase in the core inflation rate. The core inflation rate which has been well below the target range of 4 – 6 percent has entered in to inflation target range in January – March 2019. It is likely that this trend may continue with seasonal demand and the fuel price revisions that have already taken place.

Expressing optimism on the inflation outlook, Governor Coomaraswamy forecasted that inflation would remain in the range of 4 -6 percent although it is volatile to fuel price adjustments and other administrative price revisions. He explained that the uptick in inflation rate in January to March 2019 was due to non-food inflation driven by education and house rentals. A further upward pressure is expected from fuel price adjustments and likely administrative price revisions on cement, milk powder and LP gas.

The monetary policy review underpins the underlying risks of a ballooning trade deficit. Export growth remains modest. Import growth currently remains subdued due to credit restrictions on imports. The removal of such restrictions may require to let market fundamentals to work in terms of the Government policy framework particularly in the context of the ongoing IMF extended fund facility to improve the overall macro-economic conditions. But such relaxation remains a challenge in the context of slippages in government budget and recovery in imports following the removal of deposit margins of imports. The exchange rate appreciation may short live, once imports picked up in the second quarter and outflow on oil imports at high prices and values due to prevailing electricity shortfall. But it is doubtful whether in an election year imports growth could be kept under policy control for long. Reserves are kept stable and exchange rates allowed appreciating in the backdrop of short term inflows from external borrowings and subdued imports in tourism and remittances are perhaps the only supporting elements from the 1st quarter 2019 particularly, motor vehicles, milk powder and consumer durables.

Tourism and remittances are perhaps the only supporting elements from the point of view of the stabilizing balance of payments but remittance inflows of around USD 07 bn too have slowed down. The flexibility available to the Central Bank to conduct market based monetary policy in election times (2019 May) remain illusory as pressure is building from the fiscal slippages, recovery in imports and private sector for low interest rates. Exchange rate may remain vulnerable and deficits in market liquidity are likely to persist. Bank though, have reported large profits also subject to rising non-performing loans, accounting requirements, higher capital requirements and taxes. Excessively high real interest rates may be a reality with modest growth in GDP as Governor anticipated in February, 2019.

The Monetary Policy Review announcement on 10th April 2019, came at a time that the 2018 economic growth data pointed to a further slowedown in GDP growth of 3.2 percent and also following the fiscal policy stance announced in the 2019 National Budget. It will also provide the Central Bank to respond through its policy stance to the 2019 National Budget. Yet the Central Bank did not change its position on the policy rates expressing downside risks and concerns over inflation and external stability. The concerns have risen as to whether current monetary policy stance is appropriate for the country’s tumbling economy. Some also anticipate monetary policy easing in view of continued slowdown in economic growth.

However, the recent staff review by the IMF advised the Central Bank of Sri Lanka to continue to maintain a prudent and data dependent monetary policy standing ready to tightened policy rate should inflationary pressers re-emerged.

By: BiZnomics Special Economic Correspondent