Sri Lanka’s new Central Bank Governor Dr.Indrajit Coomaraswamy has now taken a personal interest in disciplining the country’s fiscal house, which has been continuously creating excess demand and economic instability for decades, as the continuity of fiscal disorder makes maintaining stable prices an extremely tough job.
Dr. Coomaraswamy pulled no punches in highlighting the apparent clash when exercising the monetary policy by the Central Bank with the fiscal policy – a prerogative of the Finance Ministry.
“It makes life a heck of a lot more difficult if you have the fiscal situation out of control,” Dr. Coomaraswamy said at the inauguration of the CIMA Business Leaders’ Summit 2016, the annual event organised by the Chartered Institute of Management Accountants (CIMA), Sri Lanka.
In Sri Lanka, monetary policy and the exchange rate policy—the key policy tools used by the Central Bank to maintain price stability—has over the years been made subservient to the fiscal indiscipline, which has been the root cause of economic instability.
Since the coalition government took office in January 2015, Sri Lanka has had two bad budgets, which gave generous handouts to the masses resulting in excess demand.
Instead of standing against this excess demand, the monetary policy too remained accommodative as the then Central Bank Governor surprised the market by cutting the key policy rates by 50 basis points in April 2015.
These policies forced the nominal interest rates to rise at least by 400 basis points and the currency took a hit as the rupee depreciated from Rs.130 to Rs.146 against the US dollar.
“Now I have a very personal interest in the fiscal situation being resolved because the job of the Central Bank and naturally that of the Central Bank Governor becomes a lot easier if the fiscal situation is stable”, said Dr. Coomaraswamy, stressing the significance of fiscal and monetary policy co-ordination.
However, Sri Lanka’s economy since liberalisation has been characterised by high budget deficits, higher inflation, higher nominal interest rates and over-valued exchange rates-significantly different from how South East Asian countries such as Singapore and Malaysia managed their economies.
“If the fiscal outcomes are non-destabilising, you can deliver very easily low nominal interest rates and stable and competitive exchange rates because we are not having to grapple with the excess demand being pumped into the system by the budget,” Dr.Coomaraswamy explained to a packed house of business executives.
Even before a month into his tenure as the Governor, Dr. Coomaraswamy had to tighten the monetary policy predominantly to avert a potential fiscal slippage likely to be caused by the suspension in the value added tax (VAT) by the Supreme Court.
“When there is a possibility of a slippage in fiscal policy, clearly monetary policy has to lean against that,” he said following a 50 basis point policy rate hike to tame the inflation, private credit and money supply in the economy, all of which had been running higher than the target levels.
Nevertheless, Sri Lanka is now on a fiscal stabilisation programme directed by the International Monetary Fund (IMF) but the continuity of such remains uncertain, as history has shown otherwise.
