Trade deficit declines in first seven months

The Sri Lankan economy performed strongly during the second quarter of 2014 with a real GDP growth of 7.8 percent compared to the 7.6 percent in the first quarter of 2014. The growth in the second quarter was led by robust performance in the Industry sector, while the Agriculture and Services sectors complemented the overall economic performance.

The growth of 7.7 percent in the first half of 2014 augurs well in meeting the expectations for the year. The low inflation environment continued as inflation remained benign in August 2014 with year-on-year (y-o-y) headline inflation at 3.5 percent and core inflation at 3.9 percent (y-o-y).

On an annual average basis, headline inflation was at 4.5 percent while core inflation was at 3.2 percent. Looking ahead, the positive impact of the recent reduction in administered prices for energy and fuel is expected to be reflected in price levels from October. Accordingly, inflation is projected to remain at around 3-4 percent by end year, compared to the previously envisaged range of 4-5 percent. The external sector remained buoyant with the momentum derived from increased earnings from exports of goods and services and workers’ remittances during July 2014.

Although the trade deficit during the month widened particularly as a result of higher expenditure on petroleum imports in July 2014, on a cumulative basis, the trade deficit in the first seven months of this year recorded a decline compared to the corresponding period in 2013. Along with these developments, continued inflows to the financial account resulted in an estimated surplus of over US$ 2 billion in the balance of payments (BOP) during the first seven months of the year. So far during the year, the Central Bank has absorbed over US $ 1 billion from the domestic foreign exchange market and gross official reserves remained above US $ 9 billion, equivalent to around 5.9 months of imports. In addition to the foreign reserves, the Central Bank also enjoys access to a further CNY 10 billion, equivalent to US $ 1.6 billion, as a result of the bilateral Currency Swap agreement entered into with the People’s Bank of China on September 16, 2014.This Swap facility, which is of a tenor of three years and renewable, is expected to further strengthen the external stability of the Sri Lankan economy.

The growth of broad money (M2b) moderated in July 2014 to 11.9 percent (y-o-y) from 13.3 percent in the previous month, although net foreign assets (NFA) of the banking system continued to improve.

On an aggregate basis, public corporations repaid debt to the banking system during the month, while net credit to the government (NCG) from the banking sector increased.

The growth of credit to the private sector from commercial banks remained moderate during July 2014.

In recent months the credit extended to the private sector by commercial banks has remained modest in spite of the continued easing of monetary policy, resulting in the accumulation of a large amount of excess liquidity in the domestic money market.

Such liquidity must ideally be used for productive economic activities instead of remaining unused for a considerable length of time in the system.The Monetary Board has also noted that the excess funds have been placed by several commercial banks on a continuous basis with the Central Bank under its standing deposit facility window, although such window has been essentially designed to provide an opportunity for OMO participants to deposit their excess liquidity at infrequent intervals to tide over temporary liquidity excesses.In that background, an appropriate monetary policy action needs to be implemented to address these concerns, particularly in view of continued low levels of inflation and benign inflation expectations.

Accordingly, the Monetary Board on September 22, decided to limit the access of OMO participants to the Standing Deposit Facility (SDF) of the Central Bank at the present applicable SDF Rate of 6.50 percent to a maximum of three times per calendar month, and any deposits at the SDF window exceeding three times by an OMO participant to be accepted at a reduced interest rate of 5.00 percent per annum. This measure which came into effect on September 23 will continue until further notice. For the remainder of September, access to OMO at the SDFR will be limited to twice per participant. The daily auction facility was suspended from September 23 until further notice. The Standing Lending Facility Rate (SLFR) will remain unchanged at 8.00 percent.

The measures would encourage commercial banks to use the substantial amounts of excess liquidity to enhance the flow of bank credit to the private sector at more reasonable interest rates, and thereby support the growth momentum of the economy, given the low inflation environment.