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Monetary Watchdog would adhere to fiscal fundamentals - Governor Central Bank

The Central Bank following the recent economic developments in the country would continue to maintain the policy rates (Short Term Interest Rate) such as the Overnight Repurchase Rate (Repo rate) and the Reverse Repurchase Rate (Reverse Repo rate) unchanged.

Repo rate was kept at 7.0 percent per annum and the Reverse Repo rate at 8.50 percent per annum.

The Governor of the Central Bank , Sunil Mendis addressing a media briefing yesterday on "Monetary Policy Review" said that the Monetary Watchdog would adhere in to fiscal fundamentals to achieve real time economic growth in the country while playing a facilitator role to help revive the Small and Medium Enterprises (SMEs)in the country which is critical for country's Gross Domestic Product (GDP).

"The Bank would continue to act on financial fundamentals in order to back sustainable economic growth. Loans are not the only way to revive the agricultural sector in the country, but we would continue to be a facilitator to bring in other wherewithal to help them compete with the regional markets", Mendis said.

He said that the recovery in the world economy, the continuation of the ceasefire and the conducive macroeconomic environment had a cascading effect on output thus helping sustain the Repo and Reverse Repo rate unchanged.

"We would will however, continue to monitor market development closely and adjust its monetary policy stance appropriately", he said.

The Central Bank report said that the growth momentum in economic activity continued in the first quarter of 2004, with GDP growing by 6.2 per cent over the same quarter in 2003.

The main source of growth has been the services sector, which contributed around 80 per cent 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.

"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 per cent in April 2004 to 1.4 per cent in May, while the point to point index rose from 4.2 per cent to 4.7 per cent.

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 per cent in May 2004 to 3.9 per cent in June, while the point to point increase has been from 5.9 per cent 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", it said.

"Commenting on the external developments it said that the recovery in the global economy has gathered pace with growth being more broad based.

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 per cent 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 per cent, with growth being observed in all three major categories of imports, i.e., consumer goods (9 per cent), intermediate goods (14 per cent) and investment goods (51 per cent).

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 services 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 per cent.

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 per cent against the sterling pound, around 4 per cent against the Japanese yen, around 2 per cent against the euro and around 5 per cent against the Indian rupee.

Reflecting these currency movements, the rupee depreciated vis-...-vis the SDR by around 4 per cent 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.

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 per cent 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.

Growth in monetary aggregates continued to remain above the projected level. Money supply on a point to point basis grew by 15.9 per cent 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 per cent 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 per cent at end May to 9.59 at the beginning of July. (SP)

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