Analysts caution against overdoing of monetary easing

Equity analysts have joined economists to caution against the possible fallout of overdoing monetary policy easing, as it could be a recipe for sparking inflation, leading to overheating of the economy.

Analysts at First Capital Research (FCR) said the all-time high Central Bank liquidity, which is typically referred to as money printing, could lead to excessive levels of money supply and thereby causing demanddriven inflationary pressures, with the recovery of the economic activities.

By December 30, 2020, the Treasury bills and bonds stock held by the Central Bank was at an all-time high of Rs.885 billion, which declined to Rs.731 billion 12 days later.

“We expect the injected cash via money printing may result in increased money supply and create demand-driven inflationary pressures with the recovery of economic activities.

Therefore, further policy easing at the upcoming policy review is unlikely, as further easing of monetary measures could result in an overheated economy,” FCR said in a note issued prior to this year’s maiden monetary policy announcement scheduled for this morning.

Record levels of money printing became the talk of the town last year, as central banks around the world resorted to unprecedented levels of monetary support, to help governments to do more for their economies to get back up from the depths reached due to lockdowns.

This became the default mechanism to fund governments around the world, including Sri Lanka’s, with the historically low interest rates pushing down the overall cost of the government’s borrowing cost.

Deficit financing out of printed money, which is also referred to as ‘Modern Monetary Theory’, came to the fore more than ever last year.

“So, the present government’s reliance on MMT is like getting a demon to work for it.

If it does not play the game within limits, the demon will turn back and swallow it,” said former Central Bank Deputy Governor W.A. Wijewardena in an Op-ed published in the Daily FT newspaper.

However, some economists argue that the world economy has reached a point where the ‘inflation-free growth’ is becoming a near possibility, with the record low commodities prices, recalibrated supply chains, renewed focus on food security and overall reduction in cost of capital.

Specially in Sri Lanka’s case, the temporary suspension of non-essential imports, the record supply of agricultural produce and the rising industrial production, could blunt most pressures on the currency and thereby the prices.

Sri Lanka forecasts a mid-single-digit inflation at between 4 to 6 percent through 2021, barring any supply shocks, as there is limited room for demand-driven inflation in the current context.