No cause for alarm over fuel price hikes

Sri Lanka has never had it good and despite the recent fuel price hike and the policy rate changes, inflation is still 'low' and there's no cause for alarm, according to a renowned statistician.

"There's very often an overreaction (to situations) amongst us. For instance there was much noise made on the fuel price increase. But inflation will not go anywhere near what it was some two years ago (due to this increase)," said Anila Dias Bandaranaike, former Central banker and statistician, addressing a forum of exporters on 'Flexible Exchange Rate: Capitalising on Opportunities and Managing Challenges' organized by Exporters Association of Sri Lankan in Colombo this week.

She reiterated that Sri Lanka isn't in the danger situation. "It's not alarming," she said, but also cautioned that it is not a good situation and that businesses will see a hard time, but it is not something to raise alarm bells. The forum saw panelists saying that the recent decisions by the Central Bank (CB) to hike policy rates by 50 basis points and remove the Us$-rupee trading band as a clear shift in the policy stance.

They noted that businesses should be concerned that there are significant risks to 2012 growth targets. Dr. Bandaranaike said that the credit growth has increased beyond the regulator's comfort level, forcing the authorities to take action to avert a balance-ofpayments crisis.

Commonwealth Secretariat Economic Affairs Division's former Director Indrajit Coomaraswamy noted that the country's exchange rate was out of alignment. "When the exchange rate was overvalued at 25% and you aggressively reduce interest rates and ease the monetary policy, it is inevitable that you have an expansion of credit and a surge of imports," he explained, adding that the rapid increase in credit and overvalued exchange rate ultimately led to a slide in the trade balance," he said.

Perfect storm of policies

He added that this condition was escalated because the physical consolidation trajectory that was hoped for was not achieved. "If you have this perfect storm of policies you will have deterioration in deficit, improvement in exports, remittances, tourism and FDI," he added.

Dr. Bandaranaike noted that imports, especially in consumer items, have been fuelled by easy credit and are largely responsible for the widening trade deficit.

Import-related credit growth standing at some 34.5% as at December 2011 shows that the country's credit growth is rising.dr. Bandaranaike noted that when coming out of a war situation there's bound to be high import growth. This resulted in the trad deficit widening which was at US$ 8.84 billion as at November 2011.

W. Wijewardena, former Deputy Governor Central Bank, joining the discussions noted that it is important for businessmen to 'assess the future' as much as possible. He said that banks will have a major problem

He cautioned that there is likely to be another fuel price increase. "With all the losses made by state entities such as CPC, CEB, Srilankan Airlines and Mihin Lanka, the government is likely to adjust the fuel prices again

in the future as the two state banks will have to take the losses of the state enterprises. He also pointed out that government's budget airline, Mihin Lanka was taken over by the government about two years ago with Treasury Bonds of Rs. 3 billion.

"The losses at the Ceylon Petroleum Corporation (CPC) and the Ceylon Electricity Board (CEB) were taken over by the state with Rs. 25 billion worth of Treasury Bonds. So the government as the big brother will take on these losses in the future," he said.

More oil price hikes

He cautioned that there is likely to be another fuel price increase. "With all the losses made by state entities such as CPC, CEB, Srilankan Airlines and Mihin Lanka, the government is likely to adjust the fuel prices again," Mr Wijewardena cautioned.

Explaining general business sense, he noted that when a net worth of a company's income is negative, it is liquidated and not functioned as a going concern. "This is different with the state entities. Their losses are absorbed by the government. The government will eventually take over these companies without any fanfare or announcements by secretly issuing Treasury Bonds." The CEB and CPC amount to around 1.5 % of the country's gross domestic product, according to Dr. Coomaraswamy.

In these unpredictable situations exporters must adjust themselves and make some informed forecasts for their businesses in the future, Dr. Bandaranaike stressed. She urged businesses to assess the business today and make their own adjustments in a bid to combat the persistent volatility in the economy. "The world is volatile. We need to deal with it and hedge the risks. We need to do our best to cope with it," she stressed. She also urged businesses to make informed decisions." Dr. Coomaraswamy noted that the most critical thing for policymakers is to build credibility.

"In the last three years we have been very happy as exporters as fuel prices were below international prices, which were a subsidy the government gave. At the same time the exchange rate was overvalued which was from an exporter's side, a tax," Mr. Wijewardena explained. "In 2001 when the exchange rate was floated it went to Rs 95 per US$ from 70. Then it settled around 80 rupees. If you stay out of the market, it will eventually find its own level," Mr. Wijewardena said.