By Uditha Jayasinghe
A possible VAT hike in two weeks to strengthen fiscal consolidation and slowing credit would give a favourable tail wind for growth recovery in the second half, believes Central Bank Governor Dr. Indrajit Coomaraswamy, underlining the thought process behind keeping policy rates unchanged yesterday.
The Central Bank yesterday kept policy rates unchanged though credit growth has remained stubborn at 28.5% in July and 28.2% in June. However, the Governor was optimistic that credit growth would slow down to about 20% by the year end as previous monetary tightening seeps into the market but not drastically enough to prevent the economy hitting its 5% growth target for 2016.
“The expansion in monetary aggregates was mainly driven by credit flows to the private sector and the Government from the banking system, while credit to public corporations continued to contract during the month,” the Central Bank said in a statement.
“The growth of credit granted to the private sector by commercial banks was at 28.5%, year-on-year, in July 2016, compared to 28.2% in the previous month.”
Despite recording 2.6% growth in the second quarter and the Asian Development Bank (ADB) downgrading Sri Lanka’s growth projections from 5.3% to 5% earlier this week, Dr. Coomaraswamy was confident third and fourth quarters would see renewed growth momentum. The upward swing is likely to be supported by parliament finally giving its stamp of approval for VAT to be increased from 11% to 15% raising Rs. 12 billion to Rs. 20 billion in the last two months of the year to help achieve the Budget deficit target of 5.4%.
“If things go according to plan the first ten days or two weeks of October it will come into force,” the Governor said referring to the VAT increase expected before Budget 2017 on 10 November. “I am confident current policies will give the outcome of 5% of growth or a little more and maintain inflation at mid-single digit level.”
“We see growth picking up in the second half of the year. The first quarter growth was revised down from 5.5% to 5.2% and in the second quarter it was a disappointing 2.6%. But there are some mitigating factors and our expectation is growth will rebound. My view as to why growth may not have slowed down as much as 2.6% is because proxies for growth like cement availability, electricity consumption, credit growth of about 25% and low inflation was evident. So the money has gone somewhere.”
A low growth base in 2015 and improved business confidence already seen in an uptick of production augurs well for growth rebounding in the third and fourth quarters. Dr. Coomaraswamy was also adamant that Sri Lanka’s 2017 growth would be higher as fiscal consolidation deepens, policy consistency improves, new projects kick in and foreign investment returns.
“I do think that we need to grow faster. We don’t yet have the framework to support 8% growth but the direction is still positive. We have positive relations with capital surplus countries and we need to encourage investment from them. By this time next year Sri Lanka should have access to a larger market as the Government works to widen agreements with China, India and Singapore,” he said.
Inflation could take a hit once VAT is increased to 15%, the Governor acknowledged, but insisted its impact would not be “drastic”. Consistent economic monitoring would continue with the Central Bank likely to continue pitching into the currency market.
“We will not allow significant fluctuations in the market. Over time we want a market oriented system.”