Inflation continued to decelerate since July this year with the rate in October 2008, as measured by the year-on-year change in the Colombo Consumer’s Price Index, dropping to 20.2 % from 24.3 % in the previous month, the Central Bank said.
It said the highest inflation was recorded in June this year of 28.2 %. Core inflation declined to 18.1% in October from 18.7 % in September, indicating that the second-round price increases, which followed the earlier increases in the prices of fuel and other commodities, are now becoming subdued, the Bank said in a statement.
These favourable developments resulted from the continuous tight monetary policy stance of the Central Bank and improvements on the supply side. On the global front, the ongoing turmoil in the financial markets has resulted in a contraction of economic activities world over, further dampening international commodity prices, the Bank said.
Commodity prices, including crude oil prices, which rose to unprecedented levels by mid-2008, have been unwinding since then and this trend is expected to continue thereby lessening the external price pressures on domestic prices. Benefiting from the downturn in international prices, the domestic fuel prices have also been revised downwards and the spillover effects of this move are expected to further ease inflation in the coming months.
The tightening of the Central Bank’s demand management policies has been effective in containing the expansion in domestic credit and monetary aggregates as evidenced in the deceleration in the growth of both reserve money and broad money, the statement said. Year-on-year growth in broad money (M2b) was 10.6 % in September 2008, compared to the growth of 16.6% in December 2007 and 17.8 % in December 2006. The sustained deceleration in the growth of monetary aggregates would help ease inflation further in the forthcoming months. “Accordingly, the Central Bank projects year-on-year inflation at end 2008 to be in the range of 17-18 % while it is expected to recede to a single digit level during 2009,” the statement added.
It said the domestic foreign exchange market has been under some pressure as a consequence of the ongoing global financial turmoil, which resulted in the withdrawal of some foreign investments in Treasury bills/bonds. The orderly management of this procss ensured that the domestic interest rates or the exchange rate were not destabilised materially, since the cushion that was built up over the first eight months of this year by absorbing the surplus foreign currency was mainly used for this purpose.
“In the meantime, there has also been a decline in some export prices of commodities, especially tea. Therefore, the Central Bank has implemented some prudential measures such as the limiting of entering into forward contracts for the sale and/or purchase of foreign exchange, preventing prepayments on import bills, and raising margin deposit requirements against Letters of Credit for the importation of motor vehicles and selected non-essential items, so as to safeguard the stability of the foreign exchange market and relieve the external reserves of any pressures due to volatility in the domestic foreign exchange market,” the statement said.
Such measures, it said, have already helped stabilise the domestic foreign exchange market. In addition, at the time of revising the Statutory Reserve Requirement (SRR) in October 2008, the Central Bank indicated that the reserve money target would also be revised once domestic market conditions improve. Accordingly, the Central Bank has decided to revise downwards the fourth quarter target for the quarterly average of daily reserve money to Rs.285.0 billion from Rs.301.7 billion. Hence, the new targeted annual average growth in reserve money is 9.7 %, down from the previous target of 11.75 %, the Bank said.