Roadmap 2020 : Central Bank to formulate policies that ensure macroeconomic stability | Sunday Observer

Roadmap 2020 : Central Bank to formulate policies that ensure macroeconomic stability

12 January, 2020
Prof. W.D. Lakshman
Prof. W.D. Lakshman

The Central Bank of Sri Lanka (CBSL) while supporting the low interest rate environment, is concerned of the challenges faced by senior citizens who depend on interest income and encourages financial institutions to come up with novel products which yield higher income for disadvantage groups.

“The reasonably low nominal interest rate could affect senior citizens. Therefore, the financial sector needs to be geared to develop new financial products for such people. The CBSL will continue to allow greater flexibility in the exchange rate where market forces will determine the value. It will facilitate policies promoting domestic production and exports to support a low inflation environment,” Governor, CBSL, W.D. Lakshman said.

“Measures will be taken to strengthen the tradable sector while a sufficient buffer will be maintained to face external shocks,” he said, presenting the Road Map 2020 which outlines the financial and monetary sector policies for this year and beyond held in Colombo last week.

“We are advocating for a dynamic, efficient and resilient financial sector where the banking sector expanded moderately during the last year. The CBSL will take necessary action to be proactive in policy crafting and implementing to ensure low inflation environment which will lead towards next economic leap forward,” he said.

Extract from the speech:

“Today, the Sri Lankan economy is at a crossroads. Decades of policy making as a sovereign nation have produced improvements in many aspects of the economy. There was significant social upliftment.

“Nevertheless, tough challenges remain – below potential growth, persistence of poverty pockets, underutilisation of productive resources, inadequate expansion and diversification of exports, shortfall of non-debt creating capital inflows, large credit and interest rate cycles, and high fiscal deficits and public debt levels.

“These challenges, which have been the outcomes of policy as well as non-policy factors, need to be addressed decisively for the economy to takeoff to a high and sustainable growth path.

“It is also essential that benefits of such high growth are distributed fairly across society and opportunities are created for all, leading to a more prosperous, happy and content nation, with equitable distribution of incomes and opportunities. Such an outcome needs innovative policies emanating from and backed by fresh innovative thinking.

“The Sri Lankan economy faced significant challenges in 2019, emanating from movements in the global economy as well as domestic developments. Within a single year, across the globe, monetary policies have reversed from tightening to easing, as economies experienced a synchronised slowdown, caused by prevailing conditions in global trade cycle, rising trade barriers, geopolitical uncertainties and numerous structural challenges.

“Fiscal and monetary measures put in place in the past to stabilise balance of payments and fiscal balances, and adverse consequences of the Easter Sunday terrorist attacks, combined with the then prevailing political uncertainties have substantially weighed down on the performance of the economy.

“The spillover effects of the Easter Sunday attacks in particular, were felt across almost all spheres of economic activity, especially in the second quarter of the year. Consequently, below potential economic growth performance continued through 2019. The economy grew at a slow pace of 2.6 per cent in real terms in the first nine months of 2019.

“The rate of growth for the whole year is likely to be around 2.8 per cent. Even in the years immediately preceding 2019, economic growth was sluggish, with the country failing to maintain the high growth momentum observed in the immediate aftermath of the end of the internal conflict.

“Policy uncertainty led to weak investor confidence and low levels of investment. Recurring natural disasters worsened conditions. The inability to address structural issues leading to a weak production economy, has caused this persistent slowdown.

“We hope, together with fiscal and other authorities, to formulate policies that will support a sustained revival of economic activity through improved utilisation of domestic resources, both physical and human. “This would help achieving the goal of the government to create productive employment opportunities in the economy on a large scale. Sustained improvement of living standards of the masses would depend on such employment creation, rather than through a continuation of the transfers-based poverty alleviation measures that the country has become accustomed to over the past several decades.

“Sri Lanka has been able to achieve commendably high human development results, thanks to past welfare policies, particularly in the spheres of education and health. It is now time to use the extensive human resource base built up over the years and new investments backed up by conducive medium to long term policies, to enhance production growth and expansion of productive employment.

“In spite of monetary policy easing, market interest rates remained high in both nominal and real terms. Private sector credit growth decelerated sharply, particularly during the first half of 2019. This prompted the Central Bank to take regulatory actions of imposing caps on deposit interest rates of financial institutions.

“This was done in April 2019, to address the issue of weak transmission of monetary policy measures. With deposit interest rates and cost of funds declining, the Central Bank removed the caps on deposit interest rates of licensed banks and imposed caps on lending rates, in September 2019.

“The intention was to induce a sizable reduction in lending rates, thereby increasing credit flows to support the revival of economic growth. As a result, most market interest rates declined, notably during the second half of 2019.

The Central Bank expects to review the caps on lending rates, once the financial institutions meet the stipulated reduction in lending rates and credit flows normalise during the year.

“In an environment of monetary and fiscal stimulus, measures are to be implemented in the near future to enhance credit flows to small and medium scale enterprises (SMEs). These measures are expected to accelerate credit growth to the private sector in 2020 and beyond, and enable a speedy revival of economic activity.

“A relief package for reviving SMEs is being designed, particularly targeting non performing advances. For those who seek relief under this package, suspension of legal action and rescheduling of loans along with some interest rate concession have been proposed.

“The revival of businesses of such borrowers is expected to be facilitated through a grace period for capital repayments and a short term working capital loan. For borrowers in the performing category, a new facility with extended repayment periods including a grace period for capital repayments under reasonable interest rates is being considered.

“The Central Bank continued its development finance and regional development activities along with concessionary credit operations during 2019 with the aim of achieving inclusive and balanced economic growth and promoting financial inclusiveness in the country. Progress was also made in formulating the National Financial Inclusion Strategy (NFIS) with technical and financial assistance from the International Finance Corporation (IFC).

“As an outcome of the collective efforts made by the Financial Intelligence Unit (FIU) of Sri Lanka and other stakeholders, in October 2019, Sri Lanka was delisted from the ‘the Grey List’ of the Financial Action Task Force (FATF). FIU continued to comply with the FATF recommendations and expanded intelligence sharing with several foreign counterparts and domestic agencies.

“In a challenging global and domestic environment, the Central Bank has achieved a great deal in meeting its objectives of maintaining economic and price stability and financial system stability, with a view to encouraging and promoting the development of the productive resources of Sri Lanka. “Going forward, in line with the philosophy of the new government, the Central Bank will continue to improve its contribution for the economy to progress as an upper middle income economy through equitable and inclusive growth of real economic activity of the country.

“The developments in the past few years have shown that, at times, there was a tradeoff between macroeconomic stability and economic growth. While stability is important, a people-centric government cannot ignore its social and human development objectives, especially when Sri Lanka is ready for its economic takeoff.

“We intend to pursue our efforts to find solutions to balance these conflicting objectives of public policy, without compromising economic and price stability and financial system stability.

“Amidst varied challenges on both domestic and global fronts, the Central Bank continued to conduct monetary policy in an increasingly forward looking manner using an evidence based approach with a view to maintaining inflation at low and stable levels over the medium term and anchoring inflation expectations at such levels. These are necessary conditions for the economy to revert to a sustainable high growth path.

“We expect to pursue our resolve to maintain inflation within a range of 4-6 per cent through a transparent, coherent, and accountable monetary policy framework going forward. Maintaining inflation at stable levels would help improve economic prosperity of Sri Lanka.

“The Central Bank will continue its dialogue with fiscal authorities. Adjustments to the Monetary Law Act to align it with global best practices are also envisaged. Improving Central Bank governance, enhancing its independence, transparency and accountability, as well as enhancing fiscal-monetary coordination to achieve price stability, are all extremely desirable features. Financial sector oversight and macro prudential policies are to be strengthened to ensure financial system stability.

“While acknowledging the importance of taking appropriate and timely policy measures, the Central Bank is also aware of the importance of effectively communicating such policies and their intended outcomes. Proper communication improves economic and financial literacy of masses, provides clarity, reduces uncertainty, improves transparency of policies and enhances Central Bank credibility.

“These would be instrumental in anchoring expectations of the stakeholders. The Central Bank has been increasingly active and open in communicating its policies. In 2020, the Central Bank envisages to further enhance its communication strategies.”