Akin to playing Santa, though a bit earlier than Christmas, the Monetary Board yesterday announced two major moves to support the economy in realising its growth potential in 2013 and beyond.
Surprising markets, the Monetary Board reduced policy rates by 25 basis points, the first-ever cut in 23 months. This move was topped up by lifting by year-end the 18% growth ceiling on lending by commercial banks.
The rate cut came amidst a Reuters poll of 13 analysts on Tuesday, which showed widespread expectations that the Monetary Board stance would remain unchanged.
The two moves, though keeping to the season’s festive mood, were however based on solid reasoning – success from recent policy measures aimed at cooling the economy and laying the ground for a quicker recovery next year. The Central Bank previously had kept rates steady since April, following two hikes made earlier in the year.
The Central Bank said yesterday that the Monetary Board at its meeting held on 11 December was of the view that the current developments provide some space to ease monetary policy while maintaining overall macroeconomic stability.
“Therefore, in order to induce a downward adjustment in market interest rates, the Monetary Board decided to reduce the policy rates of the Central Bank by 25 basis points each while allowing the ceiling on rupee credit extended by banks to expire at end 2012.
Accordingly, the Repurchase rate and the Reverse Repurchase rate of the Central Bank will be 7.50% and 9.50%, respectively, with immediate effect. At the same time, the Monetary Board was also of the view that the credit ceiling imposed for 2012 has served its purpose and such a policy measure may not be required in the near future,” the Central Bank statement added.
It said strong policy measures were adopted by the Central Bank and the Government in the early part of the year to curtail excessive credit growth and contain the high import demand, thereby arresting the imbalances that were emerging in the economy since the latter part of 2011.
“These measures were designed to curtail monetary expansion and possible future demand pressures, while the reduction in the trade deficit was expected to dampen pressure on the external sector. At the same time, a one-off increase in headline inflation was anticipated on account of the upward revisions to several administratively determined prices, which were also a part of the overall stabilisation package. A modest slowing down of economic activity was also anticipated as a result of these demand management policies, which was reflected by the projections for economic growth during the year being revised downward to 6.8%,” the Central Bank said.
In the months following the imposition of these measures, a moderation in the money supply has been witnessed, largely on account of the deceleration in credit extended by commercial banks to the private sector. Broad money growth, year-on-year (y-o-y), declined to 18.2% by October 2012 from a peak of 22.9% in April. The growth of credit obtained by the private sector from commercial banks continued to decelerate, reaching 23.5% (y-o-y), by October, from a high of over 35% prior to March 2012. This growth is expected to decelerate further to around 19% by end 2012.
At the same time, in value terms, the drop in expenditure on imports has been greater than the decline in earnings from exports, narrowing the deficit in the trade account. Accordingly, the trade deficit contracted for the second consecutive month, declining by 1% in October 2012, and this trend is expected to continue under the current flexible exchange rate regime.
The Central Bank said it has been carefully monitoring the developments in the various sectors of the economy vis-à-vis the projections for each of these sectors. As per current information, a reasonable leeway has emerged between actual credit growth and the ceiling imposed by the Central Bank, indicating a further slowdown in credit utilisation. Economic activity has also experienced some moderation with adverse weather conditions and the uncertainty in the global economy exerting some pressure on growth in 2012.
In the meantime, inflation, as measured by the y-o-y change in the Colombo Consumers’ Price Index (CCPI), increased to 9.5% in November 2012 from 8.9% in the previous month. Inflation has remained near 9% in the second half of the year as a result of the increases to administered prices and recent tariff adjustments while adverse weather conditions towards the third quarter caused prices, particularly of fresh food items, to remain high.
“Going forward, although the Monetary Board is satisfied that domestic aggregate demand has been contained to moderate levels, it is likely that y-o-y headline inflation could remain somewhat elevated in the immediate months due to supply side factors. However, as per current projections, inflation is expected to moderate towards the second quarter of 2013 and stabilise thereafter benefiting from the strong demand management policies introduced at the beginning of this year,” the Central Bank said.
Having assessed the developments and outlook discussed above and taking into consideration the expected moderation in inflation towards the second quarter of 2013 and the need to support the economy to realise its growth potential in 2013 and beyond, the Monetary Board took these new decisions, the Central Bank added.
Reuters quoted Governor Nivard Cabraal as saying said the Central Bank originally expected to make cuts from January (2013), but reduced inflationary pressures had prompted the bank to move more quickly to a pro-growth stance so that people could make spending and investment plans based on lower rates.
“The demand-driven inflation is subdued,” Cabraal told Reuters. “There is no need to prolong it. It’s an impetus now and the people can get ready with the plans ahead of the next year.”
The date for the release of the next regular statement on monetary policy will be announced in due course.
