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| Sunday, 18 July 2004 |
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Monetary Policy Review - July 2004 The Monetary Board has reviewed the recent economic developments and has decided to maintain the policy rates at their present levels: i.e., the Repo rate at 7.00 percent per annum and the Reverse Repo rate at 8.50 percent per annum. 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 continued in the first quarter of 2004, with GDP growing by 6.2 percent over the same quarter in 2003. The recovery in the world economy, the continuation of the ceasefire and the conducive macroeconomic environment were some of the factors that had a positive impact on output. The main source of growth has been the services sector, which contributed around 80 percent to the overall growth, with telecommunications and external trading being the main sub sectors driving this growth. Due to the prolonged drought and some market uncertainty, the annual growth rate is likely to be around 5 - 5.5 per cent. Prices The declining trend in inflation has bottomed out, with all consumer price indices rising gradually. The 12-month moving average of the Sri Lanka consumers' Price Index (SLCPI) rose marginally from 1.3 percent in April 2004 to 1.4 percent in May, while the point to point index rose from 4.2 percent to 4.7 percent. A similar trend has been seen in the Colombo consumers' Price Index (CCPI), with the 12-month moving average of the index rising from 3.7 percent in May 2004 to 3.9 percent in June, while the point to point increase has been from 5.9 percent in May to 6.8 per cent in June. Consumer price inflation is expected to be marginally higher than initially projected due to the adjustment of some administered prices, lower agricultural output, global inflationary pressures and the depreciation of the rupee. External Developments The recovery in the global economy has gathered pace with growth being more broad based. However, there are some possible risks to sustaining this growth momentum arising from the sustained increase in oil prices, rising inflationary pressures and global security threats. Concerns of rising inflation have also prompted some central banks to raise their policy rates to dampen demand pressure on prices. The continued recovery in the global economy has had a positive impact on Sri Lanka's external trade. Exports recorded a growth of 16 percent during the first four months of the year, with the main contribution to growth being from industrial exports, particularly the export of textiles and garments. Growth in imports was also significant at 19 percent, with growth being observed in all three major categories of imports, i.e., consumer goods (9 percent), intermediate goods (14 percent) and investment goods (51 percent. The increase in intermediate goods has partly been due to the rise in imports of petroleum products, but was also due to higher imports of textiles and other raw materials. A positive trend has been the continued growth in imports of investment goods, such as machinery and equipment, reflecting an expansion in the country's future production capacity. The expansion of exports was not sufficient to cover the increase in imports. As a result, the trade deficit widened by US dollars 158 million to US dollars 724 million in the first four months of 2004. Higher inflows to the service account from higher tourist earnings and earnings from port related activity, as well as increasing worker remittances, partly offset the impact of the higher trade deficit. Gross official reserves declined to US dollars 2,035 million (3.3 months of imports) at end May 2004 from US dollars 2,329 million (4.2 months of imports) at end December 2003, while total reserves of the country, which include foreign exchange reserves of commercial banks, have declined to US dollars 3,137 million (5.3 month of imports) at end May 2004 from US dollars 3,218 million (5.8 months of imports) at end 2003. Lower foreign inflows increased the volatility in the foreign exchange market, exerting upward pressure on the exchange rate. The Central Bank's intervention in the market helped to contain some of this volatility. During the first half of 2004, the rupee depreciated vis-…-vis the US dollar by 5.4 percent. The depreciation of the rupee has also partly been due to the recent strengthening of the US dollar in international markets. The rupee continued to depreciate against the other major currencies; around 7 percent against the sterling pound, around 4 percent against the Japanese yen, around 2 per cent against the euro and around 5 percent against the Indian rupee. Reflecting these currency movements, the rupee depreciated vis-…-vis the SDR by around 4 percent during this period. During the first half of 2004, the 24-currency real effective exchange rate (REER, 1999-100) depreciated by around 1 per cent, indicating some improvement in external competitiveness. Fiscal Developments As required by the Fiscal Management Responsibility Act, the Minister of Finance submitted a Mid-Year Fiscal Report in respect of the fiscal performance during the first four months of 2004. The report indicates that the overall deficit will be above the original estimates, but that the government is committed to maintaining it within 8 percent of GDP. In order to prevent any undue pressure on domestic interest rates and to ensure that the resources required to maintain the growth momentum are not pre-empted, the government also indicated that the deficit would be financed through a combination of foreign and domestic resources. During the first four months, the fiscal deficit was 3.2 percent of GDP, compared to 2.9 percent during the same period in 2003. Financial Sector Developments Growth in monetary aggregates continued to remain above the projected level. Money supply on a point-to-point basis grew by 15.9 percent in May 2004. Reserve money has been around Rs. 2-3 billion higher than projected, averaging around Rs. 155 billion through the month of June. The expansion in monetary aggregates has gradually shifted from a build up of foreign assets to an increase in domestic credit, both to the private and public sectors, with growth in credit to the private sector averaging over 18 percent during the first five months of 2004. The rupee market has continued to remain liquid, although the level of excess liquidity has declined. Interest rates at the primary auction for Treasury bills have remained relatively stable as the market has preferred to invest in shorter maturities, while, yield rates for Treasury bonds have increased somewhat due to market expectations. The average weighted prime lending rate (AWPR) rose by around 50 bps from 9.07 percent at end May to 9.59 percent at the beginning of July. Monetary Policy Considering the above developments, the Monetary Board has decided to keep the Bank's policy rates unchanged at their present levels. The Central Bank will however, continue to monitor market developments closely and adjust its monetary policy stance appropriately. |
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