ADB says further monetary tightening by CB cannot be ruled out

„ADB says credit to productive sectors of the economy will continue „Forecasts 5% growth in 2017 and 2018 amid tighter monetary and fiscal conditions „Cautions of possible fiscal derailment due to cost of drought relief „Sri Lanka raised policy rates by 2

The Asian Development Bank (ADB) recently said it could not rule out further tightening of the monetary policy by the Central Bank of Sri Lanka during this year to fend off any adverse developments in the economy.

ADB’S remarks on the country’s monetary policy comes just two weeks after the Central Bank raised its key policy rates by a quarter of a percentage to 8.75 percent to guard against the potential inflationary pressures, which hit almost four-year highs in March.

Releasing its flagship report on Asia Pacific economic outlook, ‘Asian Development Outlook’ (ADO) for the year 2017, the Manila-based multilateral lender said in spite of the March policy rate hike, the credit to the productive sectors of the economy would continue although the credit flows into the private sector have slowed.

“However, further monetary tightening in response to adverse developments cannot be ruled out in 2017,” ADB said in the Sri Lanka chapter in ADO 2017.

Perhaps, ADB is cautioning against possible fiscal excesses spilling over into the monetary sector, as it said, “A substantial increase in budgeted public investment will be realized only with strong revenue performance and rationalizing current expenditure to offset any increased cost of drought relief or other contingencies.”

The government runs the risk of fiscal derailment due to the ongoing drought— the worst in four decades— as a result of having to provide relief to the farmer families affected by the drought. The country’s finance minister however remains confident of meeting the fiscal deficit target of 4.6 percent of gross domestic product (GDP) set for this year.

This means, if the proposed revenue streams fail to materialize, the government will have to borrow excessively, mostly from the domestic market or forgo any public investments.

Excessive borrowings by the government from domestic sources increase money supply in the economy, heats up inflation, crowd out private sector borrowing, pushes up the interest rates, weaken the rupee and destabilize the economy.

But Central Bank Governor Dr. Indrajit Coomaraswamy in an earlier occasion said the monetary policy would lean against any form of fiscal excesses, meaning room for further tightening.

The local government elections are long overdue and such will weigh heavily on the budget as the government will have to spend excessively to shore up waning public support. Hence, analysts say the postponement of elections has an economic rationale as much as it has a political reasoning.

Meanwhile, the bleeding external sector is also unlikely have much prospects even during 2017 as economists at ADB believe any increase in exports could be offset to some degree by higher oil prices.

It was only a fortnight ago Dr. Coomaraswamy said that Sri Lanka’s economy has a very thin margin and any external shock, such as rise in oil prices, could plunge the country into a crisis. “So, what I am saying is, we are not in a crisis situation now but without that China money, we will have a very very thin margin. And if something happens, if there is an oil price hike or some kind of shock hits us, then we will get pushed into a crisis,” he said.

As the tighter monetary conditions and fiscal austerity are set to bite into the prospective domestic consumption and subdued private and public investments, ADB projects no more than 5.0 percent growth in GDP during 2017 and 2018 for Sri Lanka.