Healthy credit growth Predicted this year - CB Governor

By Sanjeevi Jayasuriya

The Central Bank's focus and functions have evolved since its formation, in response to the changing economic environment. In keeping with trends in the banking sector and to free it of the multiple objectives that were originally assigned to it the activities of the Central Bank were streamlined by amendments to the Monetary Law Act (MLA) in 2002.

The Central Bank has two core objectives, that of maintaining economic and price stability and maintaining financial system stability to encourage and promote the development of the productive resources of Sri Lanka.

The newly appointed Governor of the Central Bank of Sri Lanka (CBSL) Arjuna Mahendran in an interview with Sunday Observer said that the Central Bank will ensure that the fiscal and monetary policy directives are aligned with the government's development agenda.

Excerpts of the interview

Q. What is the present state of the economy?

A. Following the end of the civil conflict in Sri Lanka in 2009, economic growth has averaged around 7 percent and inflation has settled to single digit levels.

Sri Lanka's relatively robust growth performance during the past few years was recorded amidst diverse and challenging global conditions and weather-related domestic challenges.

The financial system has remained stable in spite of short-term threats such as gold price volatility and large interest rate movements.

Credit flow to the private sector has picked up and healthy credit growth is expected in 2015. The exchange rate has been maintained at broadly stable levels with some intervention by the Central Bank.

Although the import coverage of the gross official reserves is at a satisfactory level, the reserve coverage in terms of short-term debt and liabilities of the country needs to improve further.

The state of public finances was revealed by the Minister of Finance in his statement to Parliament on January 29, and accelerated fiscal consolidation is expected by further reducing the Budget deficit to 4.4 percent of GDP, which would improve the state of the economy further.

Fiscal measures introduced will ensure a more equitable distribution of economic growth while lowering the debt burden of the country.

Q. What action plan does the Central Bank hope to implement in 2015 and beyond?

A. The Central Bank's objectives are maintaining economic and price stability and financial system stability to encourage and promote the full development of the productive resources of the country.

The Central Bank will ensure that price stability is maintained by conducting monetary policy to keep inflation at low and stable levels.

Due to administered price and tax reductions, inflation will remain in single digits during the year. At present, no demand pressure has been observed, and the Central Bank will take appropriate and timely action to address excessive demand pressures.

The exchange rate policy will be aligned to meet the Central Bank objectives more effectively.

The Bank will also ensure that the interest rates for deposits and loans are appropriate, which will encourage and promote the full development of the productive resources of the country as envisaged in the Monetary Law Act.

With regard to financial system stability, supervision will be strengthened further while an appropriately balanced level of regulation will be used so as not to discourage market development. In addition to strengthening policies to meet these objectives, the Central Bank will also carry out its agency functions transparently and diligently.

Q. What past action will continue?

A. The Central Bank of any country is primarily responsible for price stability. Sri Lanka was traditionally considered a high inflation economy and this has changed for the better in the past few years.

By advising the government to take measures to improve productivity and with timely monetary policy actions, the Central Bank hopes to continue this low inflation environment, which will result in macro-economic stability.

Q. What would be the new look economy of Sri Lanka by the end of this year?

A. Sri Lanka is identified as an economy with relatively robust economic growth among emerging market economies, and characterised by low levels of inflation and unemployment.

Sri Lanka's annual real economic growth averaged 7 percent during the past three years. Sri Lanka's economic growth in 2015 is expected to be in the range 7.5-8 percent, supported by growing domestic demand and improving external demand.

The outlook for 2015 would be strengthened further by benign features such as well-anchored inflation expectations around a mid-single digit level and steadily declining unemployment.

The external sector rebound is expected to continue in 2015 with a favourable adjustment in the external current account supported by increasing export earnings from goods and services owing to the strengthening of US and other key export destinations and the likelihood of regaining GSP+ concessions in Europe. Moderating import expenditure amidst falling commodity prices and steady flow of foreign earnings from workers abroad will be positive for the current account.

The favourable developments in the external sector will build international reserves despite some outflows relating to short-term debt servicing. The government has shown credible commitment on fiscal consolidation with an estimated budget deficit for 2015 at 4.4 percent, down from 4.6 percent estimated before, well below the estimates for 2014. Benefiting from these developments, the per capita GDP is expected to reach USD 4,000 by 2015.

Q. Will there by any change in policy directions and strategies?

A. All policies and strategies of the Central Bank will be revisited, and any weaknesses will be addressed to strengthen policy predictability, transparency and the credibility of the Bank.

Q. How does the CB plan to stabilise the rupee?

A. We believe that the exchange rate needs to broadly reflect the demand and supply in the foreign exchange market.

Hence, it will continue to be determined by market forces with minimal intervention by the Central Bank. During recent weeks, the exchange rate showed some adjustments responding to market conditions.

However, the Bank will continue to monitor the adjustments of exchange rate to ensure that such changes are gradual and smooth and do not result in large misalignment in the real exchange rates of the Sri Lanka Rupee with other currencies.

Q. Will the banking sector consolidation process continue at the same pace?

A. An external committee has been appointed to look into the banking sector consolidation process. The Central Bank will provide inputs for evaluation by the external committee.

Q. Are the macro-economic fundamentals strong as they appear to be?

A. The strength of macroeconomic fundamentals of an economy are portrayed by indicators such as strong and sustainable level of GDP growth and low unemployment, stability in inflation and interest rates, stable exchange rates as determined by market conditions, level of international reserves and fiscal sector consolidation.

If any one of the indicators become weak and unstable it would impact other indicators too. Sri Lanka has maintained a satisfactory level of GDP growth over a reasonable period, along with low levels of unemployment, low and stable inflation rates, and low and positive real interest rates, while maintaining international reserves at adequate levels and fiscal sector consolidation.

However, there are concerns about relatively high public debt, which the government intends to address.

Q. The drop in foreign reserves - is it not of concern?

A. The present level of foreign reserves is equivalent to about five months of imports, which is well above the standard of three months of imports. Sri Lanka has maintained this level of reserves despite foreign currency debt service payments and other short-term outflows.

Having considered the expected foreign currency inflow and estimated outflow, the short-term fluctuations that were observed recently in international reserves need not necessarily be of concern.