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Friday, April 8, 2011

Central Bank should increase interest rates, says HSBC

Banking giant is bullish on growth, ‘Lanka can withstand global oil price increase’

Global banking giant HSBC, which also functions as a ratings advisor to the government, says Sri Lanka’s strong economic growth momentum could help it weather the effects of rising global oil prices but urged the Central Bank to be proactive and increase interest rates in a bid to contain raising domestic inflation.

"We are very bullish on Sri Lanka and we have overnight revised its economic growth forecast for this year from 7.2 percent to 8 percent. We believe the political arrangements and peace would drive this growth. But success would come at a cost and inflation is a significant risk," HSBC Asian Economic Research Co-head Frederic Neumann told journalists in Colombo via teleconference yesterday (7).

"We believe the Central Bank should be proactive and tighten monetary policy further in order to anchor inflation and stabilise growth," he said.

"High oil prices could harm the economy but we are not too worried. Sri Lanka’s economic growth momentum and strong remittances would cushion the raise in oil prices and we believe the economy would not be derailed.

"It is always a difficult job for Central Bank’s (to stabilise prices) but they have to take a more medium term view. Rising interest rates would contain inflation and also help attract much needed foreign investments," Neumann said.

He went on to say that several emerging Asian economies including China and South Korea would require a sharper increase in monetary policy rates, while Sri Lanka, along with India and the Philippines would not have to be aggressive.

Yesterday we reported that the Asian Development Bank believed that the Central Bank would have to increase policy rates further this year in order to combat accelerating inflation as global commodity prices increase.

Inflation accelerated to 8.6 percent in March on domestic supply constraints after floods destroyed food crops earlier this year. Petrol and diesel have been increased by Rs. 10 and Rs. 3 per litre this month on rising global prices. All this, together with the April festivities, are expected to cause a spike in inflation within the next few months.

Earlier this year, the Central Bank cut policy interest rates, a move which surprised many because India and China and several other Asian economies raised there rates to curb rising inflation.

But this was deliberately done to give the market a signal that private sector lending had a lot more room to grow before fuelling demand driven inflation.

Domestic banks’ total lending to the private sector as at end December 2010 reached Rs. 1,333.8 million, up 27.8 percent from a year earlier which was Rs. 1,043.8 billion, generating new loans amounting to Rs. 290 billion. Foreign banking sources gave loans amounting to Rs. 10 billion, with total credit amounting to Rs.160.4 billion, up 6.6 percent from Rs. 150.4 billion a year ago.

New loans to the sector from domestic banking units amounted to Rs. 30.9 billion in January 2011. The credit stock from domestic banking units reached Rs. 1,364.7 billion by the end of January 2011, up 30.1 percent from a year earlier.

Policy rates are set at 7 percent for overnight deposits of the banking system with the Central Bank and 8.5 percent for overnight borrowings.

Contradiction...

While ADB and HSBC believe an increase in policy rates was necessary, with ADB Lead Economist for Sri Lanka Narhari Rao saying high inflation could undermine economic growth, the International Monetary Fund (IMF) earlier this week suggested that monetary policy tightening would be harmful at this stage.

IMF Resident Representative for Sri Lanka Dr. Koshy Mathai said raising policy rates would increase market interest rates. This would slow down the economy as businesses find it difficult to borrow leading to low employment opportunities.

"The Central Bank cannot bring oil prices down," he said.

Although excess liquidity in the banking system (over Rs. 70 billion) remains a concern as it could fuel demand driven inflation, Dr. Mathai said private sector credit growth was still below the pre-2008/09 crisis levels.

He said the IMF was looking at other options available to the Central Bank to locking in the excess liquidity and containing inflation, without having the need to increase interest rates.

source - www.island.lk