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| Sunday, 14 November 2004 |
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| News Business Features Editorial
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Monetary Policy Review-November 2004 The Monetary Board has reviewed recent economic developments and prospects and has decided to increase the Central Bank policy interest rates, i.e., the Repurchase (Repo) rate and the Reverse Repurchase (Reverse Repo) rate by 50 basis points to 7.50 per cent and 9.00 per cent, respectively, to be effective from the close of business on 10 November 2004. The following is an assessment of the factors that were taken into consideration in arriving at this decision. Real Sector The growth momentum in economic activity that began in early 2002 continued in the second quarter of 2004, with the GDP growing by 5.2 per cent. Accordingly, GDP growth in the first half of the year was 5.7 per cent. With the rising international and domestic demand especially for the products of the textiles and apparel sector, the industrial sector has grown by around 4 per cent during the first 8 months of the year. Within the services sector, the telecommunications sector has contributed strongly to the growth momentum, while port activity also grew with the expansion in international trade. A healthy growth was also seen in the leisure sector with the improvements in the tourism industry. Tourist arrivals increased by 11 per cent up to end September 2004 and the arrivals are expected to accelerate in the coming months as well. The growth momentum in these sectors is likely to continue during the rest of the year, but the drought and high international oil prices would cause some downside impact. Given these developments, the overall growth for the year is likely to be around 5.0 - 5.5 per cent. Prices Inflation, as measured by the 12-month moving average change of the Colombo Consumers' Price Index (CCPI), was on a declining trend since early 2003 and reached its lowest level of 3.7 per cent in April 2004. It has risen gradually since then and increased from 5.4 per cent in September to 6.1 per cent in October 2004. On a point-to-point basis CCPI increased from 11.6 per cent in September to 12.1 per cent in October 2004. A similar upturn was seen in the inflation as measured by the Sri Lanka Consumers' Price Index (SLCPI). The 12-month moving average change of the SLCPI increased from 3.1 per cent in August to 4.1 per cent in September 2004, while on a point-to-basis, the index rose by 10.9 and 14.4 per cent in the two respective months. External Sector Trade data for the first nine months indicate that both exports and imports have been growing. On a cumulative basis, during this period, exports grew by 9.0 per cent, while imports grew by 20.5 per cent resulting in a widening of the trade deficit to US dollars 1,571 million from US dollars 940 million in the comparable period in 2003. Exports are expected to increase further during the balance period of the year, mainly benefiting from expansions in apparel and tea exports. The high growth in imports was partly due to the increased cost of oil imports and the rise in investment imports. Meanwhile, the services account and the transfers account recorded surpluses due to improved receipts on tourism and transfers. Worker remittances grew by 11 per cent in September 2004, and are expected to grow by 6 per cent in 2004. However, the current account deficit expanded with a sharp rise in the trade deficit. Inflows to the capital and financial accounts have not been sufficient to finance the widening current account deficit, thus resulting an overall BOP deficit of about US dollars 245 million for the first nine months of 2004. These developments, together with the CBSL intervention in the foreign exchange market to contain volatility in the exchange rate, resulted in some reduction in the official reserves. Gross official reserves declined from US dollars 2,069 million (about 3.3.months of imports) in August to US dollars 1,943 million (about 3.1 months of imports) in September 2004. The rupee has depreciated against the US dollar at a relatively faster rate of 7.0 per cent up to end October 2004. During this period, the rupee also depreciated against the Sterling pound by 9.6 per cent, against the Japanese yen by 7.7 per cent, against Euro by 8.3 per cent and against the Indian rupee by 7.2 per cent. Reflecting these currency movements, the 24 currency nominal effective exchange rate (NEER, 1999=100) depreciated by 7.7 per cent, while the 24 currency real effective exchange rate (REER, 1999=100) depreciated by 3.6 per cent by end October 2004, strengthening the country's external competitiveness. Government Finance Total government revenue during the first eight months of the year was 9.6 per cent of GDP, while total expenditure and net lending were 15.2 per cent of GDP. Preliminary estimates up to August 2004 indicate that the overall budget deficit for the first eight months of 2004 is 5.6 per cent of GDP. The government relied more on domestic sources in financing the deficit, and total domestic borrowing amounted to 4.4 per cent of GDP during the first eight months of the year. Measures taken by the government are expected to increase the revenue collection and contain expenditure increases in the second half of the year. Monetary Sector Monetary aggregates have expanded at a faster rate than anticipated. The broad money supply (M2b) expanded by 18.1 per cent in September mainly driven by the higher than expected growth in credit to both the private sector and the government sector. The growth in credit to the private sector has been around 21 per cent in September 2004 on a point-to-point basis. Meanwhile, net credit to the government rose by 28 per cent during the year to September 2004. Market interest rates have increased gradually, with some volatility during the first ten months of 2004. The weighted average call money rate, which was 7.60 per cent at end 2003, increased to 8.25 per cent at end October. This further rose to 8.9 per cent in the first week of November. Other market lending rates have also shown a similar increase. The acceleration in the monetary aggregates so far in the year indicates the possibility of the onset of demand-fuelled pressure on inflation. The Central Bank is of the view that a tightening of monetary policy is therefore, required to curb the build up of inflationary pressure and inflationary expectations in the economy. Monetary Policy Considering the above developments, the Monetary Board has decided to increase the Central Bank policy interest rates, i.e., the Repurchase (Repo) rate and Reverse Repurchase (Reverse Repo) rate by 50 basis points to 7.50 per cent and 9.00 per cent, respectively, to be effective from the close of business on 10 November 2004. The Central Bank will continue to monitor market developments and the behaviour of the monetary aggregates closely and adjust its monetary policy stance appropriately. |
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