CB highlights challenges to financial stability

The Central Bank (CB) interpreted the high security expenditure that is inevitable this year as an advantage as the terrorism threat is all over the world and called upon the business community to continue with their investment plans in Sri Lanka.

Describing the challenges in meeting price, economic stability and financial system stability in 2007 and beyond, CB's Road Map: Monetary and Financial Sector Policies for 2007 report, looks at high defence expenditure from a different angle and said that because all concerns regarding security provides a certain "discount" which could be an advantage in a highly competitive global business field.

The report recognises the high crude oil price as the major challenge this year.

It increases the import bill, widening the current account deficit, adversely impacts on the exchange rate stability, raises domestic fuel prices causing a serious supply side shock and raises inflation, it said.

The report highlights all possible external and internal shocks and vulnerabilities to the financial system stability.

The continuing high growth in private sector credit could pose a threat to price and financial system stability.

First it could deteriorate the quality of assets of commercial banks and this could increase the risk of high non-performing loans in the future. Such expansion of credit could generate inflationary pressure in the economy through increased aggregate demand.

The financial stability of the country will also be threatened by money laundering, terrorist financing and pyramid schemes as a result of rapid integration of the Sri Lankan economy with global financial markets. To arrest such situations, the report proposes a continued regulatory vigilance and timely intervention.

Continuing the high budget deficit is another challenge in the conduct of monetary policy. Such deficit requires borrowings by the government from the banking system, making it difficult to maintain the monetary expansion along a pre-determined, tight path.

The report said that though rapid infrastructure development is a strong contributory factor towards achieving sustainable high growth, the timely mobilisation of resources for infrastructure development while maintaining budget deficit and debt at reasonable levels are challenges for a developing country such as Sri Lanka.

Maintaining foreign currency reserves at a reasonable level is also a challenge. Maintaining a sound reserve level is important to mitigate external shocks and to ensure the exchange rate fluctuations within a reasonable level.

However, the 2006 Financial stability report of the CB said that the financial system in the country is resilient and that there are no imminent threats that may endanger its stability.

Emergence of South Asia as a new force in the world economy would provide new opportunities for Sri Lanka to achieve higher economic growth. Simultaneously geo political uncertainties that would impact global economic stability would pose a threat to meet external sector targets in 2007, the report said.

(GW)