Lanka's economy on threshold of new era - CB Governor

Central Bank Governor Ajith Nivard Cabraal said that Sri Lanka is on the threshold of a new era in its economy and the platform of sustained growth has now been firmly established. It is now up to all of us - those in the government sectors, as well as private sectors to make use of these opportunities and move fast.

Q: The Sri Lankan rupee is depreciating continuously while inflation is also on the increase. What are the reasons for this situation?

A: Recent macroeconomic developments, especially the external sector developments, indicate that the depreciation of the exchange rate experienced recently is excessive and inconsistent with economic fundamentals.

During the first seven months of 2007, export earnings increased by nearly 16 per cent to US dollars 4,259 million, while imports grew by only 4.2 per cent to US dollars 6,065 million.

As a result, the trade deficit narrowed down to 1,806 million from US dollars 2,140 million in the first seven months of 2006. Meanwhile, worker remittances increased significantly by around 19 per cent to US dollars 1,533 million during the first seven months of 2007.

The realised FDI during the first half of 2007 amounted to over US dollars 260 million as compared to US dollars 200 million in the corresponding period in 2006.

Financial flows to government too increased substantially during the first half of 2007 to US dollars 603 million as compared to US dollars 358 million during the same period in 2006.

As a result of all these strong external sector developments, the overall balance of payments (BOP) has so far recorded a surplus of around US dollars 151 million during the first seven months of 2007. Reflecting the BOP surplus, the gross official reserves increased to US dollars 2,681 million by end July 2007 from US dollars 2,526 million at end 2006.

Therefore, we can only surmise that the current depreciation is mainly driven by speculative activities and perhaps through an organised campaign to destabilise the country and economy through highly exaggerated negative stories in the economic, defence and political fronts.

I am compelled to say this, because the prevailing economic fundamentals certainly do not warrant such a depreciation of the rupee, and hence the actual reason has to be otherwise.

Sri Lanka's inflation by the end 2006 on a point to point basis was 19.3 per cent and increased to 20.5 per cent in January 2007. Inflation decreased to 13 per cent by June 2007 largely due to tight monetary policy of the Central Bank.

However, it increased once again to 17.3 percent in August, mainly because of the revision of the administered prices of petroleum products, bus fares, increase in prices of essential imported good items such as wheat flour and milk powder and other supply shocks.

We believe that the adjustment of the domestic petroleum prices to reflect international prices as a result of the elimination of government subsidies, while causing a spike in current inflation, would contain future inflation since this would be a one-off increase in the current price level.

Q: What measures has the Government/Central Bank taken to control the situation?

A: Like most Central Banks worldwide, the Central Bank of Sri Lanka intervenes in the foreign exchange market as and when necessary to contain high and excessive volatility in the exchange rate.

At the same time, the Bank continues to share relevant economic information, particularly on current macro-economic conditions, with market participants and the public, to create an informed market.

In our view, inflation reached its current levels both due to demand and supply side factors. The Central Bank is responsible for maintaining price stability through the demand side management.

In other words, the Central Bank is responsible in maintaining the country's money supply at a level, which is compatible with the country's total production of goods and services to maintain the aggregate demand in the economy at a non-inflationary level.

As the growth in money supply remained high since mid 2004, the Central Bank has, over the past 2 years, been adopting a tight monetary policy stance. In fact, two to contain the monetary expansion, the Central Bank announced a tight reserve money target at the beginning of this year and has been successful in achieving all indicative targets so far during the year.

In addition, the Bank increased its policy rates by 350 basis points since end 2004. Also, some prudential measures such as high provisioning requirements on loans were taken to influence and certain high credit growth. We have also sometimes used moral suasion to encourage banks to lend in more productive sectors.

As with any measures to deal with inflation, market interest rates moved up and through such policy the Central Bank has been able to contain high credit and monetary expansion. If not for our measures, inflation would have been much higher.

The Government also has taken several measures such as removing tariff on essential food items to contain the price increases of essential commodities, which has helped to keep prices in some check.

According to our current forecasts, the year-end inflation is now expected to be around 13-14 percent. Next year, we believe it would come down further. However, we all naturally need to be cautious about risk factors beyond our control such as further increases in oil prices, and whenever possible, we need to ensure that we use such resources carefully and prudently.

Q: Overall what is your assessment about the economic fundamentals of Sri Lanka?

A: As confirmed by key economic indicators, economic fundamentals of the country continue to remain strong notwithstanding various external and internal shocks.

In fact Standard and Poor's, one of the world's top independent international credit rating agencies has up-graded Sri Lanka's credit rating outlook from negative to stable, just last month.

As I stated earlier, the external sector of the economy is improving satisfactorily in 2007, and the fiscal consolidation process is also continuing. With further improvement in government revenue and a decline in government debt as a percentage of GDP the situation should improve further in time to come. At the same time, the continuation of the tight monetary policy with some prudential measures will help to curb the demand driven inflation as well.

Q: In this situation what would be the economic growth rate this year? Will it be on target?

A: Sri Lanka's economy grew by a commendable 7.4 percent in 2006 following a 6 percent growth in 2006. During the first half of 2007, the economy grew by 6.2 per cent, indicating a continuation of the high growth.

The average growth during the past 10 years was 4.9 percent and the growth during the past 50 years was 4.2 per cent. In comparison, over 6 per cent continuous growth over the past three years is remarkable, given the series of internal and external shocks that we have faced.

In fact, this would be the first time in the history of our country, that we are going to record over 6 per cent of growth in the third consecutive year. When the situation is such, why are some people so negative in their outlook and comments? Will they be satisfied only if the economy grows at 15% or 20% per annum?

As we all know, the original growth target for 2007 was 7.5 percent. However, largely due to weather related lower performance in the paddy and tea sectors and security related drop in the tourism sector during the first half of 2007, it is likely that economic growth in 2007 would be lower than the original estimate.

At the same time, we now see that tea and tourism sectors are showing strong indications of recovery and according to our revised estimates, the economic growth in 2007 would probably be between 6.5 - 7.0 per cent. Such a growth rate would be a tribute to our entire business sector, big and small, and we should all be happy that we are maintaining this momentum.

It is also likely that our per capita income would probably be exceeding US$ 1,500 by the end of this year and this too is very encouraging. To us, these developments confirm that we are fast approaching the growth mode that should propel the country forward.

There are also many positive features that we should take from this scenario. Therefore, it is time that all of us continue to build on these trends and take the economy to the next stage of development.

With the liberation of the Eastern Province from terrorist control, and the resulting economic growth that it could generate as well as with the implementation of many of the infrastructure projects over the next 2 -3 years.

There is also no reason as to why we would not be able to move towards the growth target of 8 per cent or more over the next few years. If we are to genuinely make a difference in the living standards of the people of our country, we should all strive to achieve such targets and not be discouraged by some of the doom sayers, both local and international, who seem to have bent on belittling and down playing the progress of our country.

Q: Any other comments?

A: Yes. Macroeconomic management is an extremely challenging function. This is more so in recent times, particularly in Sri Lanka due to various external and internal shocks.

Such shocks include the high and volatile oil prices, tsunami reconstruction, escalation of terrorism and the need to deal with it strongly, and intermittent natural disasters; eg. landslides, floods and droughts. In addition to these challenges, we also have had to grapple with flawed and misleading remarks, comments and stories regarding our economy which sometimes dampen expectations and discourage investors.

In some instances, we see that inaccurate stories and flawed analysis on the economy that appear in certain media is due to innocent ignorance or superficial analysis based on bits and pieces of information collected at random.

In such circumstances, it could perhaps be excused because the damage to the economy is done accidentally or unknowingly. But unfortunately, we also see some instances, where the misreporting campaign is carried out knowingly and deliberately. Those efforts are highly repulsive and should be condemned.

We sincerely hope that our business sectors which has shown a strong resilience would continue to maintain the momentum without falling prey to these organised negative sentiments.

Needless to say, our economy has great potential to far exceed expectations and those who are with a positive frame of mind would surely have tremendous opportunities to do well for themselves as well as the country.

The foreign direct investments last year were the highest ever in our history and there is sufficient progress to show that even such level could be exceeded this year. The security situation has been improving and many countries have already softened their travel advisories.

Large scale infrastructure projects are taking shape. Sri Lanka is on the threshold of a new era in its economy and the platform of sustained growth has now been firmly established. It is now up to all of us, i.e., those in the government sectors, as well as private sectors to make use of these opportunities and move fast. I am sure, those who take that attitude will benefit immensely.