Thursday, May 26, 2022

The Central Bank’s Incapability to Guide Monetary Policy

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What is the monetary policy?

Monetary policy is the method through which a central bank oversees the supply and cost of money circulating in an economy, primarily to accomplish the macroeconomic goal of price stability.

The Central Bank of Sri Lanka is in charge of monetary policy in Sri Lanka. That primarily entails establishing policy interest rates and regulating the economy’s liquidity. The central bank’s financial activities influence interest rates in the economy, influencing the attitudes of lenders and borrowers, economic activity, and, ultimately, the rate of inflation. As a result, the central bank employs monetary policy to manage inflation and maintain it on a predetermined course.

What is the policy for?

Economic and price stability refers to the absence of significant variations in the overall level of prices in the economy, which aids in the achievement of long-term economic growth. When prices change at a low pace, they have little impact on the financial decisions of the economy’s actors, namely families and enterprises. Furthermore, price stability effectively stabilizes inflation expectations among the general population, making it more straightforward to manage real inflation at modest and steady levels. As a result, regular pricing would not influence economic decisions about what to create and how to produce, allowing for effective resource allocation and contributing to financial stability and long-term prosperity.

Monetary Policy Target 01 of 2022

In light of current and anticipated macroeconomic trends, the Monetary Board of the Central Bank of Sri Lanka resolved to implement specific policy measures to strengthen macroeconomic stability during its meeting on January 19, 2022. As a result, the Monetary Board decided to

  1. a) Increase the Central Bank’s Standing Deposit Facility Rate (SDFR) and Standing Lending Facility Rate (SLFR) by 50 basis points, to 5.50 percent and 6.50 percent, respectively;
  2. b) Distribute funding for critical import bills for fuel purchases among licensed banks based on their foreign currency inflows.
  3. c) Require that all registered tourism establishments only accept foreign currency for services provided to visitors from outside Sri Lanka.
  4. d) extend the payment of an additional Rs. 8.00 per US dollar for workers’ remittances required to pay in addition to the incentive of Rs. 2.00 per US dollar provided under the “Incentive Scheme on Inward Workers’ Remittances” until April 30, 2022; reimburse the operational costs borne by Sri Lankan migrant workers when remitting money to rupee accounts via licensed financial institutions and other formal channels beginning February 1, 2022; and raise interest rates

What Issues Need Guidance?

Despite its growing international debt, Sri Lanka never defaulted until recently. The current economic disaster, defined by a lingering dollar problem, skyrocketing living costs, and the possibility of food scarcity in the coming years, is threatening to demolish that record. Last week, the rupee’s fall offered some momentum to inflation, although the effects may be short-lived.

One economic expert who asked to remain anonymous said that “it’s as if we’re all fumbling in the dark with no guidance from the Central Bank or Finance Ministry on such important economic indicators and how they change over the year.”

While predicting has never been more challenging, it is the authorities’ job to offer a prognosis for each of these critical economic indicators with at least fair accuracy so that others may make educated business and financial decisions.

In general, the Central Bank steps up to the plate each year, whether in January or December of the preceding year, to provide its economic prognosis and intended path in a much-anticipated road plan release.

But that did not occur in 2022, as the six-month economic stabilization road map grabbed center stage in October and is set to expire on March 31, 2022, with little to no progress accomplished.

While inflation appeared to be declining until mid-February, Russia’s war with Ukraine on February 24 and the subsequent surge in oil and commodity prices are projected to weigh on future inflation. In February, Brent crude oil prices increased by 24.1 percent to the US $113.5 per barrel, while natural gas, coal, wheat, and steel prices increased by 16 percent, 76%, 39%, 25%, and 0.6 percent, respectively.

According to the Colombo Consumption Price Index, consumer prices in Sri Lanka grew by 15.1 percent in the year to February 2022, reaching a 13-year high, while food costs rose by 25.7 percent. Sri Lanka’s private sector credit, a vital indicator of economic dynamism, increased by 13.1 percent in 2021, with commercial banks disbursing Rs. Eight hundred eleven billion in new credit.

The Central Bank’s target short-to-medium-term inflation rate of 4 to 6 percent came to a breached status several months ago.

Monetary Policy

Answers to the Issues in Sri Lankan Economy

Monetary Policy Contraction

A contractionary monetary policy is a primary way of reducing inflation. A contractionary policy seeks to shrink an economy’s money supply through lower bond prices and higher interest rates.

The Federal Funds Rate

Three main tools are available to undertake a contractionary policy: The first option is for the central bank to raise interest rates. In the case of the United States, this is the Federal Reserve. The Fed Funds Rate refers to the rate at which some banks borrow funding from the government to earn money, but to do so; they typically lend it at increased speeds.

The country needs reserves 

The second strategy is to boost the number of money banks can legally keep on hand to ensure withdrawals. When banks have to keep more capital in reserve they will have to lend to customers. Consumers will borrow less if they have less to lend, resulting in lower expenditure.

Reducing the money supply

The third way is to lower the money supply directly or indirectly by establishing policies that support the decline of the money supply. Calling in debts owing to the government and raising interest rates on bonds to entice more investors to acquire them are two instances of this.

The latter strategy boosts the currency’s exchange rate owing to increased market demand (through direct investment if your rates have risen compared to overseas rates) and, as a result, promotes imports and lowers exports.

Disclosure

These are purely the opinions of the author based on observations and analysis of financial platforms and a study of public reviews and ratings on how the Central Bank of Sri Lanka still doesn’t provide any guidance on the economic problems that have been arising. Excerpts from various sources have been used to clarify the facts in this article. A glossary of all the sources used can be found at the end of the article. This article is for educational purposes only and is not financial advice.

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