Monetary Easing – Central Bank’s Policy Dilemma Comments Off on Monetary Easing – Central Bank’s Policy Dilemma 953

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.

Monetary-EasingThe 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.

Monetary Easing Chart

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.

Monetary-EasingThe 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

IMF Extends Sri Lanka’s Fund Facility 0 839

Manuela Goretti

Ms. Manuels Goretti who has almost 13 years of work experience in the International Monetary Fund currently is a Deputy Division Chief and Asia and Pacific Department and has held this position from February 2018 to date. Prior to this position Ms. Goretti was the Advisor to the 1st Deputy Managing Director for a little over two years.

She has served as Deputy Chief in the office of Risk Management Senior Economist European Department and Economist in Emerging Markets. She has experience in country assignments in Haiti, Romania and Bulgaria, Greece, Turkey, Poland, Peru and Portugal.  She led the IMF staff Mission to Sri Lanka in February 14- 28, 2019 to undertake Fifth Review of Extended Fund Facility (EFF) supported Economic Reform Program of Sri Lanka in February 2019.

The IMF mission expressed optimism and predicted that economy is gradually stabilizing, however had to re-calibrate their own projections in two instances on the back of poor economic data and fiscal slippage from its original targets. Economic growth outlook for 2019 is expected to improve to about 3.5 percent from 3 percent in 2018. Inflation has regained in January and is projected to reach 4.5 percent in 2019. The current account deficit widened to 3.2 percent in 2018 but is expected to narrow in 2019 benefiting from the recent exchange rate correction.

The Mission noted that the primary surplus in the Budget in 2018 fell short of the program target due to weak revenue mobilization.  The mission further noted foreign exchange reserves target missed by sizable margins.

The staff mission also observed that sustain fiscal consolidation through revenue effort and prudent spending is priority and welcomed government commitment to raise primary fiscal surplus to 1.5 percent of GDP in 2019 and reduce the budget deficit to 3.5 percent of GDP in 2020 and 2 percent of GDP over the medium term by adopting sound fiscal rules and new medium term debt strategies.

The Mission emphasized the need for a concerted effort by all stakeholders to preserve the gains of the economic reform program, support macro-economic stability and strengthen the economic resilience considering the high level of public debt and low international reserve buffers.

The Mission highlighted the need for an improved transparency, accountability and cost efficiently of large state owned enterprises. It also advised government to move forward with plans to bring Sri Lankan Airlines on sound commercial and financial footings and has insisted upon completing energy pricing reforms in order to address fiscal risks.

The staff team endorsed the commitment of the Central Bank to rebuild international reserve buffers and allow exchange rate flexibility. However, rapid slippage in the rupee and cost escalations has pushed the government to reign back the free fall with new fiscal measures on consumer imports.

It advised the Central Bank of Sri Lanka to continue to maintain a prudent and data dependent monetary policy, and stands ready to tighten policy rate inflationary pressures which re-emerged.

The team also emphasized the need for the government’s consistent implementation of the Inland Revenue Act and the modernization of the Inland Revenue and Customs Departments.

The Mission in its deliberation left three messages with the Government

  1. Revenue based fiscal consolidation and state enterprise reforms are needed.
  2. A prudent policy mix and exchange rate flexibility to rebuilt foreign exchange reserves are critical to strengthen resilience and market confidence.
  3. Strengthening institutions and fast tracking structural reforms can lay the foundation for strong sustainable and inclusive growth in Sri Lanka.

The IMF staff mission agreed to the government’s request to extend the EFF arrangement for an additional year to allow more time for the completion of the economic reform agenda. The IMF Board of Directors is expected to consider Sri Lanka’s request favorably in 2019.

By: BiZnomics Special Economic Correspondent

The Price We Pay For Not Understanding The ‘Price’ 0 1113

In the book titled ‘Marx’s ‘Theory of price and its Modern Rivals’, Sri Lankan born and educated Prof. Howard Nicholas exposes the flaws in the many theoretical debates in money, price and inflation. This he does by revealing the inconsistencies and contradictions in economic theories submitted to explain price. This is nothing new in Sri Lanka and many developed countries attributable to the fact the certain economists, due to a false understanding, are misled on what price is all about. Therefore, let us examine this false interpretation and try to understand the real parts that from PRICE which we play in commerce.

According to Prof. Nicholas, Orthodox economists starting with David Ricardo have not quite understood the concept of ‘price’ and how it is computed. He argues that the explanation of price by Marx, who had a deep understanding of the capitalist system, is more logical and clear. To understand Price we have to first understand how commodities bearing a price tag are produced and marketed. Prof. Nicholas who refers to this process as the- Production Cycle’ explains that present day economists go astray since at the outset they focus only on the process of exchange, assuming individuals are naturally endowed with commodities. This mistake causes them to ignore cost of production and focus on individuals and their choices when explaining prices.

A second important point made by Prof. Nicholas in his book is that when explaining price, from the outset we need to bring money into the picture. This is, to explain prices as money- prices. When products calculate the values of their commodities, they do so in terms of money thereby setting money prices. Buyers of goods in markets make payment in accordance with these money- prices. According to economic orthodoxy, the prices that matters are relative prices. That is, the price of one product in terms of another and not in terms of money. In fact, although this may not be so apparent when reading standard economics text books, money has no role to play in the basic explanation of prices. It only makes its appearance when macro-economic phenomena, in particular the aggregate level of prices are considered.

The third major argument prof. Nicholas advances is that the basis for explanation of cost of production of the commodity as its money cost of production, needs to be seen as the labour time spent in production. This is what Marx referred to as the value of commodity. Labour time spent in production amounts to money costs, when money represents labour time by itself. This happens when money is used by producers, to depict the value of the product. The importance of explaining prices is perhaps best been by producers, to depict the value of the product. The importance of explaining prices is perhaps best seen by the present downward pressure on global prices, resulting from the massive technological change across the globe. Despite unprecedented levels of printing of currency by Central Bank of major countries, world inflation rate has continued to fall down. This underlines the importance of labour productivity in explaining price, and the incorrect explanation of money and price by economists. It may also be the clearest practical support for Marx’s price theory as seen by Prf. Nicholas

By : Dr Kenneth De Zilwa