CB rate cut must be monitored carefully
View(s):The Central Bank (CB) decision last week to ease interest rates, despite warnings by the International Monetary Fund (IMF), could trigger inflation and put further pressure on the economy, economists say.
“On the other hand, with economic growth coming down the only way to prop up growth is through lowering interest rates. But that comes at a (huge) cost,” a senior economist, who like others spoke to the Business Times on condition of anonymity, said.
A day after the IMF Executive Board of Governors issued a report saying “with rising wage and cost pressures, directors cautioned against a further easing of monetary policy in the near term,” the CB on May 10 reduced inter-bank interest rates by 50 ‘basis’ points.
A reduction in interest rates between banks is a signal for the rates of commercial banks to come down for deposits and loans, bankers said. The CB over the past few weeks has been urging banks to reduce rates to encourage borrowings and boost economic growth.
Economists said the CB ‘play’ in interest rates follows a sharp slowdown in economic growth and a worrying 8 per cent fall in export earnings in the first quarter (January to March) of the year. Imports have also come down by 16 per cent in the same period but analysts said this is not enough to balance Sri Lanka’s foreign exchange payments.
Either way, economists say the CB and the Government are trapped because of poor monetary and fiscal policy management earlier and also burgeoning state spending in unviable and no-return, image-boosting projects.
“With a (possible) election next year, the Government is cautious in enforcing unpopular structural reforms in the economy. That’s why the decision to pass-on real electricity rates, which could have eased the debt burden of the Ceylon Electricity Board (CEB), had to be partially reversed due to public agitation,” the senior economist said, adding “reducing the debt (of state agencies) is the only way forward but that’s an unpopular measure.”
Another economist, attached to a leading commercial bank, said the interest-rate cut is a short term measure. “The Government needs to put the house in order first and tackle major imbalances. Exports are sliding and imports haven’t fallen enough,” he said adding that lowering interest rate will lead to a hike in imports of consumer goods and put pressure on foreign exchange payments.
Additionally the Treasury is struggling to raise revenues with tax income falling below target and demands from loss-making state agencies rising. After the IMF turned down a request for a US$1 billion loan as budgetary support, the Treasury is going with a ‘begging bowl’ to the World Bank with a $700 million request. The word ‘begging bowl’ was coined in the 1980s during Ronnie de Mel’s tenure as Finance Minister when the then government desperately sought international support.
Bankers said that in the past six months, Treasury borrowings from the two state banks have increased to pay public sector wages and meet other recurrent expenditure. “When the Treasury account in these banks gets overdrawn, the banks come to the market for funds, pushing up rates,” a bank money market dealer said, adding that commercial borrowings by the CEB and the Ceylon Petroleum Corporation had also increased in the past few months.
“The hike in electricity rates will ease pressure on the CEB and the state banks but at a cost to the consumer,” he said.
The senior economist said the CB has to closely monitor interest rates in coming weeks and if there is any overheating of the economy like a rise in inflation for instance, the rates have to go up again.
He said second half economic growth last year was less than 5 per cent, contrary to CB projections, while the first half of this year too would see the same level of growth. The CB has said the economy grew by 6.4 per cent in 2012 and is set to grow by 7.5 per cent this year.
“I think this figure is unrealistic and not achievable this year,” he said, adding that, “any way, figures or economic growth data means nothing to people on the street and that’s where monetary policy is dictated.”
In the meantime the IMF on May 9 also commended Sri Lankan authorities for prudent policy implementation, which, supported by the IMF $1.16 billion loan, has facilitated the achievement of robust growth and poverty reduction in a difficult environment. The senior economist said structural reforms – cutting costs and losses at the CPC and the CEB – is the way forward but that’s affects the popularity of the Government. “So tinkering with the policies with short terms goals in mind is the way things are happening now which is not sustainable at all,” he added.
Follow @timesonlinelk
comments powered by Disqus