No purpose of the CB's monetary policy in April - Who is responsible for policy errors ?

This article is to highlight the meaninglessness of the CB's last monetary policy decision (April 4, 2023) as reflected in the press statement. The statement is nothing but a bunch of words and sentences, not even understood by the writers.

Policy decision

To maintain policy interest rates at current levels of 15.5% and 16.5%. I predicted this outcome with possible underlying reasons in my article released in the early morning of April 4.

However, contents in the press statement are highly misleading and erroneous and do not show any connection to the policy decision as highlighted below in 9 categories of contents of the policy statement.

Content 1

"Having considered the recent and expected economic developments, and macroeconomic projections on domestic and global fronts, the Board viewed that the maintenance of the prevailing tight monetary policy stance is necessary to ensure that monetary conditions remain sufficiently tight to facilitate the continuation of the ongoing disinflation process amidst the improvements in market sentiments following the finalisation of the Extended Fund Facility (EFF) from the International Monetary Fund (IMF) and the downward shift in elevated market interest rates reflecting the falling risk premia."

My Concerns/Comments

• The press statement does not provide what are the recent and expected economic developments and macroeconomic projections on domestic and global fronts that support the policy decision as referred to in the press statement.

• The connection of improvements in market sentiments following EFT and downward shift in market interest rates to the disinflation process is not stated.

• The downward shift in market interest rates reflecting the fall of risk premia is against the present tight monetary policy and boosts the inflationary pressures now broad-based and sticky around 50%.

Content 2

"Despite a sizeable impact from the recent hike in electricity tariffs and envisaged second round effects of previous hikes, headline inflation moderated in March 2023, mainly reflecting a larger-than-expected reduction in food inflation."

"A faster deceleration of inflation is expected from April 2023 with the reduction in domestic prices of essentials following the greater passthrough of the moderation of global commodity prices and the recent appreciation of the Sri Lanka rupee, and the large disinflationary impact arising from the base effect. The subdued aggregate demand on account of tight monetary and fiscal policies and improved domestic supply conditions will ensure the envisaged disinflation process in the period ahead, supported also by anchoring inflation expectations. Accordingly, headline inflation is projected to reach single digit levels by end 2023 and stabilise at desired levels thereafter over the medium term."

My Concerns/Comments

• If inflation decelerates due to above factors, the purpose of monetary policy with red hot interest rates is unwarranted as the monetary policy has no connection to those factors. Therefore, the CB is grossly responsible for the loss of national production and employment caused by the erroneous monetary policy.

• Envisaged disinflation path is not given specifically and inflation projection given in the statement is not accepted even by the CB itself (stated as neither a promise nor a commitment).

• How inflation expectations are anchored to support disinflation process is not described and research information is not given.

• The projection of the single digit inflation by end of 2023 is not consistent with the projection of 15.2% (average 28.5%) reported in the IMF programme agreement. 

Content 3

"The external sector outlook improved with the finalisation of the IMF-EFF, along with further financing assistance envisaged in the period ahead."

My Concerns/Comments

The details given under the above item are not relevant for the monetary policy, especially as their impact on the inflation or disinflation path is not sated in the press statement.

Content 4

"Given these developments and with a view to allowing the exchange rate to be market-determined, the Central Bank discontinued the announcement of daily guidance on the exchange rate and revoked the mandatory forex sales requirement from the converted export proceeds and workers’ remittances from early March 2023. As a result of these policy measures, and the gradual improvement in liquidity in the domestic foreign exchange market and improved market sentiments, the exchange rate recorded a notable appreciation thus far during 2023, despite some volatility. Moreover, the Central Bank built up its gross official reserves, which were estimated at US dollars 2.7 billion as at end March 2023, including the swap facility from the People’s Bank of China."

My Concerns/Comments

If so, the CB has been engaged in a serious policy error by pursuing a guidance exchange rate policy and mandatory forex sales requirement. Therefore, relevant CB officials should be prosecuted for the macroeconomic cost of the two policies, i.e., forex illiquidity, poor market sentiments, currency depreciation and decline in foreign reserve, as inferred from the above statement.

Content 5

"Notwithstanding the increase in policy interest rates in early March 2023, both deposit and lending interest rates have continued to decline, reflecting largely the market guidance provided by the Central Bank and the improved liquidity conditions of the domestic money market. A notable moderation in the yields on government securities was also observed driven by the improvements in market sentiments."

My Concerns/Comments

• The CB's market guidance to reduce interest rates is against the present tight monetary policy and its key objective of taming inflation.

• Improvement in market sentiments in government securities market as stated cannot be expected by current market fundamentals, i.e., significant uncertainties in debt default, debt restructuring, debt unsustainability, rising fiscal funding requirements and super tight monetary policy in the country and world. Therefore, moderation in yield rates as stated should be an insider act of the CB like guidance in market interest rates and exchange rate as stated above.

Content 6

"Accordingly, the spread between policy interest rates and market interest rates is expected to narrow further, thus better aligning the market interest rates with the policy interest rates. However, forward looking real interest rates remain positive with falling inflation, thereby keeping monetary conditions sufficiently tight to tame any adverse demand pressures in the period ahead."

My Concerns/Comments

• The narrower spread between policy interest rates and market interest rates has no relevance to the current red hot interest rate policy and is against the inflation control-based interest rates policy.

• The CB does not have any information regarding real interest rates or target on real interest rates for inflation control. Therefore, tight monetary conditions in terms of real interest rates as stated has no relevance or basis on the present monetary policy model or its current decision.

Content 7

"The economy is projected to recover gradually towards the latter part of 2023, supported by improvements in domestic supply conditions, enhancement in business and investor sentiments along with the anticipated improvements in foreign exchange inflows, envisaged reduction of market interest rates, and the impact of policy measures being implemented to strengthen the growth outlook. The recovery of activity is expected to sustain in the medium term underpinned by the implementation of the economic adjustment programme outlined in the IMF-EFF"

My Concerns/Comments

If so, policy rates should be raised now just like in other countries as inflation is sticky around sugar high 50%. Therefore, the recovery of the economy as  stated above is a baseless expectation.

Content 8

"Volatility in global financial and commodity markets increased amidst the anticipation of a deviation from tighter financial conditions in advanced economies and the materialisation of downside risks, among others. Nonetheless, the major central banks continued to raise policy interest rates with a view to ensuring the timely return of inflation to their medium term targets. Furthermore, as the major central banks announced coordinated measures aimed at providing liquidity support to preserve global financial stability, some normalisation in market conditions was also witnessed."

My Concerns/Comments

Contents are are grossly erroneous as highlighted below and has no relevance to the CB monetary policy decision.

• No market anticipated in any deviation of tighter financial conditions in advanced economiesķ. In fact, all speculate further monetary tightening led by consecutive rate hikes throughout the year 2023 in view of untamed high inflationary pressures.

• Volatility in financial markets was purely a result of the banking turmoil in the US, UK and Europe consequent to heightened interest rates risk as a result of red hot policy interest rates.

• Coordinated measures stated above are not for the purposes stated, but to provide dollar liquidity through daily currency swaps by the Fed to central banks in Canada, UK, Europe, Switzerland and Japan.

• Central banks provided ample liquidity in own currency to clam down the banking turmoil caused by outflows of deposits and risks of contagion as appropriate in respective countries where no coordination was reported.

• The wording "timely return of inflation" is grossly meaningless as no central bank states when inflation will return to target.

Content 9

"The Board remains ready to act appropriately and assure the normalisation of the interest rate structure no sooner the price pressures in the economy are sufficiently contained in the period ahead."

My Concerns/Comments

• Normalization is a meaningless word as nobody knows the level of normalisation of the interest rate structure whether policy rates or market interest rates or all rates. Central Banks' habit it to raise policy rates in a cycle and reverse the rates in next cycles without any idea of normalization or desirable level of interest rates.

• Central Bank have no way to know the price pressures in the economy. They only will know the movements of consumer price index which shows the price pressures of selected consumer products and not the price pressures in the economy responsive to the monetary policy.

Concluding Remarks

• Given the present outlook of local and global inflationary pressures broad-based and sticky, almost all central banks keep on raising interest rates, despite the slight disinflation witnessed in recent few months.

• As the situation is catastrophic in Sri Lanka with bankruptcy and debt unsustainability, the CB keeping policy interest rates unchanged is unacceptable in both policy professionalism and policy principles behind the current monetary policy model and monetary law provisions.

• Almost all contents in the policy statement are erroneous and irrelevant on the present policy decision. It is the habit generally observed in all monetary policy statements. It is clear that even the writers of the policy statement do not understand the contents or words in the statement.

(This article is released in the interest of participating in the professional dialogue to find out solutions to present economic crisis confronted by the general public consequent to the global Corona pandemic, subsequent economic disruptions and shocks both local and global and policy failures.)

P Samarasiri

Former Deputy Governor, Central Bank of Sri Lanka

(Former Director of Bank Supervision, Assistant Governor, Secretary to the Monetary Board and Compliance Officer of the Central Bank, Former Chairman of the Sri Lanka Accounting and Auditing Standards Board and Credit Information Bureau, Former Chairman and Vice Chairman of the Institute of Bankers of Sri Lanka, Former Member of the Securities and Exchange Commission and Insurance Regulatory Commission and the Author of 10 Economics and Banking Books and a large number of articles published. 

The author holds BA Hons in Economics from University of Colombo, MA in Economics from University of Kansas, USA, and international training exposures in economic management and financial system regulation)