Central Bank Governor Dr. Indrajit Coomaraswamy addressing his last press conference on Friday – Pic by Ruwan Walpola
Says fiscal stimulus must be carefully structured to prevent overheating
Keeps rates steady, says need to see impact of easing already done
Private sector credit only Rs. 144 b in first 10 months, target was Rs. 780 b
AWPR expected to reduce 70 basis points further to 9.50% by end 2019
AWLR is projected to decline by around 120 basis points to below 12.50% by March 2020
Supports reforms including new MLA, argues it will de-risk economic perceptions
Govt. to announce economic framework, will hold talks with IMF in coming days
By Uditha Jayasinghe
Limited fiscal space to accommodate the stimulus package announced by the Government exists, said Central Bank Governor Dr. Indrajit Coomaraswamy last week, but warned it would have to be well-structured and a close watch is needed to keep the economy from overheating and undermining debt sustainability.
Addressing the last monetary policy press conference as Governor, Dr. Coomaraswamy acknowledged that there was a modicum of fiscal space for stimulus but emphasised on the need to ensure sustainability, both of fiscal space and debt repayments. On Friday (29 November), the Central Bank announced that the Monetary Board had decided to keep policy rates unchanged. Sri Lanka’s current debt to GDP ratio is about 82%.
“The Monetary Board decided to continue with its accommodative stance to policy rates. They took that position because the external environment continues to be favourable. The US Federal Reserve has taken a passive stance and capital flows are not a problem. Growth continues to be muted and the output gap also persists, so that again argues for relaxation of policy. Though there has been an uptick in inflation and we expect that to continue in December and reach about 6%, inflation expectations are well-anchored and the outlook is stable. We expect inflation to return to the mid-single digit level during the course of next year,” Dr. Coomaraswamy told reporters.
Private sector credit, in absolute terms, recorded an increase of Rs. 26.2 billion in October following an increase of Rs. 53.7 billion in September while cumulative increase during the first 10 months of 2019 was only Rs. 144.6 billion. Year-on-year growth of credit to the private sector further moderated to 5.1% in October from 6.1% in September. Dr. Coomaraswamy acknowledged that private sector credit growth was well below what was expected originally.
“There was in absolute terms an expectation that private sector credit would grow by Rs. 780 billion, but it is more likely to be Rs. 250 billion or Rs. 270 billion this year, so it is considerably less. As far as monetary aggregates are concerned, at present it is growing at about 6%, and most of the year, b2b is expected to grow between 6% and 7%,” he said.
“What these two indicators seem to show is that there is capacity for some expansionary policies in terms of aggregate demand in the system. This seems to indicate that the fiscal stimulus could possibly be accommodated without overheating of the economy, provided it is structured within a clear, stable framework. The exchange rate has also been relatively stable. It has appreciated by little over 1% so far and that may be attributed to the significant improvement in the trade deficit, which has also led to a deficit in our current account from 3.5% of GDP last year to 2.6%. Pressure on capital outflows has also been less. All these argue for an accommodative or relaxing of monetary policy.”
However, Dr. Coomaraswamy argued that it was necessary to take stock of the impact of monetary policy loosening done so far and pointed out that with the fiscal stimulus package, as well as the salary increase the public sector will receive in January 2020, there is reason for some degree of caution as far as loosening monetary policy is concerned. The Government is also expected to hold talks with the International Monetary Fund (IMF) on the continuation of their program, which is expected to end in mid-2020.
“The whole rationale behind the fiscal stimulus package is to put more aggregate demand in the system to revive the economy. We have had persistently slow growth for some time now, and there is space to do this. But it is extremely important that we are very vigilant and that this fiscal stimulus must be kept in a framework, which does not undermine fiscal sustainability, and even more importantly, it must not undermine debt sustainability.”
“It is encouraging that the Government will be making a statement to show how this stimulus package will be accommodated without undermining stability, without it leading to a situation where there is overheating of the economy, and there is balance of payments pressure and inflationary pressure emerging. That broad framework within which fiscal consolidation has been taking place, within which we have been able to maintain both fiscal and debt sustainability, will be continued. That’s the framework. But we need to be very vigilant and make sure this is accommodated without undermining stability within the system.”
Responding to questions on the proposed Monetary Law Act, Dr. Coomaraswamy noted his support for it remained despite his decision to step down. The bill is now before Parliament but is unlikely to be passed before the General Elections, given its importance. The Governor also insisted that it would “de-risk” the economy and help raise money for debt refinancing.
“It would be surprising if such a major piece of legislation were taken up but I’m still very hopeful it will go through. I have firm conviction that this is something good for the Central Bank and for the country. Embedding inflation targeting will ensure consistent policymaking and prevent the Central Bank from participating in primary auctions that takes out high powered money – the most inflationary form of financing of the Budget that leads to a lot of problems – and by law, the Central Bank will be prevented from doing that.”
“Given a deficit and debt dynamics, we need to give a clear signal to all market participants that we have these clear frameworks for formulating stable policies. By having this commitment through this proposed law, it would involve de-risking the economy, in how it is perceived, and it would be extremely helpful for our internal and external financing requirements. There is also a whole section on macro prudential measures and one of the lessons moving forward from the global financial crisis is that this is an area where central banks must build capacity and be very active. The new bill puts this into law as well.”
SL Bonds slammed by new Govt.’s aggressive tax cuts
LONDON (Reuters): Sri Lanka’s benchmark government bonds slumped to their worst-ever week on Friday, after the new Government’s move to immediately slash value-added tax (VAT) and other major taxes stoked worries about the cost of plans.
Dollar-denominated bond due to be paid back in 2027 and 2028 fell for the eighth straight session between 3.4 cents and 4.1 cents, taking them from roughly 96 cents on the dollar to around 90 cents and pushing yields up to 8% from 6.8%.
In its first week of office, the new Sri Lanka Podujana Peramuna (SLPP) Government, led by former Civil War-time Defence chief Gotabaya Rajapaksa, has cut VAT from 15% to 8%, reduced some corporate taxes, scrapped a ‘nation-building’ tax and a PAYE tax on wages, and introduced a zero tax rate for tourism sectors which source 60% of inputs locally.
Analysts at Citi calculated the VAT cut alone could cost Rs. 200 billion ($1.11 billion), or 1.3% of the country’s GDP, while the overall package of cuts would significantly widen the gap between revenues and expenditure.
“We are forecasting the budget deficit at about 5.8% of GDP in 2019, but the annual deficit run-rate could approach closer to 7% of GDP in the 1H20 barring corrective fiscal measures,” they said in a note to clients.
The changes are also likely to add pressure to the country’s lowly ‘B’ sovereign credit rating, with both S&P Global and Fitch both already warning about fiscal losing in recent weeks.
Sri Lanka’s debt-to-GDP ratio is currently around 75% but was expected to gradually subside in coming years.
“While we highlighted fiscal risks given the tax-cut filled campaign policies in Gota’s manifesto, we weren’t sure how much would be carried out given fiscal constraints. We underestimated their political resolve,” the Citi note said.
CRIB to get new scoring system
The Central Bank will be issuing a new scoring system for the Credit Information Bureau (CRIB).
Central Bank officials on Friday said a scoring system between 250 and 800 points will be introduced to help lending institutions determine the creditworthiness of their prospective clients.
“We hope the scoring system will give better information for lending entities and help them take an informed decision; 250 is the lowest band and 800 is the highest.”
The Central Bank believes this could support better decision-making by banks and financial institutions.
CB revokes NatWealth Securities suspension
The Central Bank on Friday said it has revoked the suspension on primary dealer NatWealth Securities Ltd.
The Monetary Board of the Central Bank of Sri Lanka, acting in terms of the Local Treasury Bills (Primary Dealers) Regulations No. 01 of 2009 and the Registered Stock and Securities (Primary Dealers) Regulations No. 01 of 2009, has decided to revoke the suspension of NatWealth Securities Limited from carrying on the business and activities of a Primary Dealer from 4.30 p.m. on 30 November, the Central Bank said in a short statement.