Rising inflation bugs Central Bank

Central Bank appears to be perhaps hapless and helpless over rising inflation, judging by its latest assessment on the macro economic situation.

The significant rise in international food prices, further exacerbated by the spiraling prices of crude oil, has exerted upward pressure on the inflation of many countries, particularly from the second half of 2007.

The Bank admitted last week that in Sri Lanka too, inflation, as measured by the point-to-point change in the New Colombo Consumers’ Price Index - CCPI (N), reached 21.6 percent in February compared with 20.8 percent recorded in January 2008 while the annual average inflation also moved up to 17.0 percent in February from 16.4 percent in January.

“The continuous rise in international food prices as well as domestic supply constraints have led to an increase in inflation higher than the expected level. However, with the dissipation of the impact of these developments, inflation is expected to decelerate towards the second half of the year,” the Central Bank said following the March monetary policy review last week.

Central Bank was targeting a inflation rate of 10-12% by year end and analysts were skeptical over the manner in which rising inflation is being addressed.

Following its March review, the Bank said reserve money, the operating target of the monetary policy framework, has been within a tight growth path since 2007 achieving its respective quarterly targets and is poised to be well within the first quarter target for 2008.

The lagged effects of the more disciplined movement in reserve money has gradually been observed in broad money, the growth of which, has decelerated to 15.8 percent by end January 2008 from the higher rates in the range of 20-22 percent seen in 2007.

The deceleration in the broad money supply has resulted from a decline in domestic credit, which comprises of credit to both the public and private sectors. The expansion in credit to the private sector continued its deceleration and reached 18.3 percent at end January while net credit to the government from the banking sector has declined by Rs. 10.5 billion during the month. However, the increased utilisation of credit by public corporations, particularly the Ceylon Petroleum Corporation in the face of rising international oil prices, remains a concern.

The increased inflow of foreign exchange so far during 2008 have further strengthened the external reserves and stablised the exchange rate. The Central Bank has absorbed around US dollars 357 million from the market.

Subsequently, the gross official reserves are estimated to have increased to US dollars 3.6 billion, which is sufficient to finance 3.7 months of imports. As a result of the Central Bank absorbing foreign exchange from the market, a substantial amount of rupee liquidity was injected to the market, creating an excess liquidity situation. Therefore, the Central Bank has been continuing its aggressive Open Market Operations by selling Treasury bills in the secondary market while refraining from subscribing to maturing Treasury bills in its own stock to siphon off this excess liquidity and contain the reserve money expansion with the intent of curbing excess demand and thereby, demand-pull inflation. As these efforts have resulted in a sharp decline in its net holding of Treasury bills, on 13th March 2008 the Bank issued its own Securities so as to ensure uninterrupted absorption of liquidity to contain monetary expansion.

The Bank will release of the next regular statement on monetary policy on April 22.