Stimulus should not undermine debt sustainability: CB Chief

Monday, 2 December 2019 01:47 -     - {{hitsCtrl.values.hits}}


 Central Bank Governor Dr. Indrajit Coomaraswamy addressing his last press conference on Friday – Pic by Ruwan Walpola


  • Says fiscal stimulus must be carefully structured to prevent overheating

  • Keeps rates steady, says need to see impact of easing already done

  • Private sector credit only Rs. 144 b in first 10 months, target was Rs. 780 b

  • AWPR expected to reduce 70 basis points further to 9.50% by end 2019

  • AWLR is projected to decline by around 120 basis points to below 12.50% by March 2020

  • Supports reforms including new MLA, argues it will de-risk economic perceptions

  • Govt. to announce economic framework, will hold talks with IMF in coming days


By Uditha Jayasinghe 

Limited fiscal space to accommodate the stimulus package announced by the Government exists, said Central Bank Governor Dr. Indrajit Coomaraswamy last week, but warned it would have to be well-structured and a close watch is needed to keep the economy from overheating and undermining debt sustainability. 

Addressing the last monetary policy press conference as Governor, Dr. Coomaraswamy acknowledged that there was a modicum of fiscal space for stimulus but emphasised on the need to ensure sustainability, both of fiscal space and debt repayments. On Friday (29 November), the Central Bank announced that the Monetary Board had decided to keep policy rates unchanged. Sri Lanka’s current debt to GDP ratio is about 82%.

“The Monetary Board decided to continue with its accommodative stance to policy rates. They took that position because the external environment continues to be favourable. The US Federal Reserve has taken a passive stance and capital flows are not a problem. Growth continues to be muted and the output gap also persists, so that again argues for relaxation of policy. Though there has been an uptick in inflation and we expect that to continue in December and reach about 6%, inflation expectations are well-anchored and the outlook is stable. We expect inflation to return to the mid-single digit level during the course of next year,” Dr. Coomaraswamy told reporters. 

Private sector credit, in absolute terms, recorded an increase of Rs. 26.2 billion in October following an increase of Rs. 53.7 billion in September while cumulative increase during the first 10 months of 2019 was only Rs. 144.6 billion. Year-on-year growth of credit to the private sector further moderated to 5.1% in October from 6.1% in September. Dr. Coomaraswamy acknowledged that private sector credit growth was well below what was expected originally.

“There was in absolute terms an expectation that private sector credit would grow by Rs. 780 billion, but it is more likely to be Rs. 250 billion or Rs. 270 billion this year, so it is considerably less. As far as monetary aggregates are concerned, at present it is growing at about 6%, and most of the year, b2b is expected to grow between 6% and 7%,” he said. 

“What these two indicators seem to show is that there is capacity for some expansionary policies in terms of aggregate demand in the system. This seems to indicate that the fiscal stimulus could possibly be accommodated without overheating of the economy, provided it is structured within a clear, stable framework. The exchange rate has also been relatively stable. It has appreciated by little over 1% so far and that may be attributed to the significant improvement in the trade deficit, which has also led to a deficit in our current account from 3.5% of GDP last year to 2.6%. Pressure on capital outflows has also been less. All these argue for an accommodative or relaxing of monetary policy.”

However, Dr. Coomaraswamy argued that it was necessary to take stock of the impact of monetary policy loosening done so far and pointed out that with the fiscal stimulus package, as well as the salary increase the public sector will receive in January 2020, there is reason for some degree of caution as far as loosening monetary policy is concerned. The Government is also expected to hold talks with the International Monetary Fund (IMF) on the continuation of their program, which is expected to end in mid-2020.

“The whole rationale behind the fiscal stimulus package is to put more aggregate demand in the system to revive the economy. We have had persistently slow growth for some time now, and there is space to do this. But it is extremely important that we are very vigilant and that this fiscal stimulus must be kept in a framework, which does not undermine fiscal sustainability, and even more importantly, it must not undermine debt sustainability.”

“It is encouraging that the Government will be making a statement to show how this stimulus package will be accommodated without undermining stability, without it leading to a situation where there is overheating of the economy, and there is balance of payments pressure and inflationary pressure emerging. That broad framework within which fiscal consolidation has been taking place, within which we have been able to maintain both fiscal and debt sustainability, will be continued. That’s the framework. But we need to be very vigilant and make sure this is accommodated without undermining stability within the system.”

Responding to questions on the proposed Monetary Law Act, Dr. Coomaraswamy noted his support for it remained despite his decision to step down. The bill is now before Parliament but is unlikely to be passed before the General Elections, given its importance. The Governor also insisted that it would "de-risk" the economy and help raise money for debt refinancing.

“It would be surprising if such a major piece of legislation were taken up but I’m still very hopeful it will go through. I have firm conviction that this is something good for the Central Bank and for the country. Embedding inflation targeting will ensure consistent policymaking and prevent the Central Bank from participating in primary auctions that takes out high powered money – the most inflationary form of financing of the Budget that leads to a lot of problems – and by law, the Central Bank will be prevented from doing that.”

“Given a deficit and debt dynamics, we need to give a clear signal to all market participants that we have these clear frameworks for formulating stable policies. By having this commitment through this proposed law, it would involve de-risking the economy, in how it is perceived, and it would be extremely helpful for our internal and external financing requirements. There is also a whole section on macro prudential measures and one of the lessons moving forward from the global financial crisis is that this is an area where central banks must build capacity and be very active. The new bill puts this into law as well.”  


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