The monetary and financial sector policies of 2017 and beyond in the Road Map 2017 of the Central Bank provides useful insights on future directions on key economic policies. The proactive policies in the Road Map 2017 seem to be beneficial for Sri Lankan economy.
The Governor Dr. Indrajit Coomaraswamy emphasizes that national policies would be data driven rather than politically driven. This is imperative for the proper analysis of the economy and for forecasting. We should focus on the long-term rather than the short-term when preparing economic policies for the country. For this, the Central Bank highlights the importance of data compilation methods, which should be up to international standards. This would help the public as well as international donors and agencies to rely on the data and guide their policies.
The Central Bank also stresses that an overvalued exchange rate is not sustainable as it is at the cost of limited external reserves of the nation. As the Central Bank has rightly pointed out, what we need is a flexible exchange rate in order to benefit from the forces of demand and supply in the international market. For this, our exports need to be competitive with other exporting countries with high quality of exports.
There were instances in the previous year when Sri Lanka tried to keep the Rupee overvalued by using external reserves. This was not sustainable as the country loses her scarce foreign exchange reserves. What we should try instead, is to increase the demand for our exports, diversify our export base, sustain an investor-friendly climate and attract more foreign direct investments to the country. Regrettably, last year’s foreign direct investments were only about 300 million US dollars.
As a country which faced twin deficits – fiscal and trade deficits for a number of years, policies planned by the Central Bank are indispensable. It is essential to contain Sri Lanka’s fiscal deficit as it directly leads to complicated monetary and financial policies. To attain this, a more simplified tax structure, prioritizing of national expenditure, minimizing of tax evasion and tax avoidance are crucial as discussed in my previous columns.
If fiscal performance is improved, there would be fiscal space to attend to other urgent requirements of the economy. As the Road Map 2017 rightly explains, excess demand situations are created due to high fiscal deficits which would sequentially create inflationary pressures in the economy. This would again raise nominal interest rates, leading to high influx of imports as the domestic supply is limited. All these macroeconomic factors are inter-connected and would negatively affect the balance of payments and the exchange rate.
A shift from monetary targeting towards inflation targeting is one other policy of the Central Bank in order to achieve its core objectives of economic and price stability, and financial system stability. In line with international trends, what the Central Bank tries to accomplish through the above is to let inflation remain at mid-single digit levels in the medium-term.
Supervision and regulation
The Central Bank also mentions the need for proper supervision and regulation of banks and all other financial bodies in the country in order to maintain a reliable financial system. Encouraging good corporate governance practices and establishing risk management systems are also recognized by the Central Bank as necessary to promote the risk culture and risk appetite of both government and private sector financial organizations.
The focus of the Bank is to establish a strong financial sector, rather than numerous individual financial institutes, thus emphasizing on organic consolidation of bank and non-bank institutions. Similarly, the Central Bank mentions promoting financial inclusion, adopting equitable and inclusive growth, further relaxing of foreign exchange transactions, and encouraging financial literacy, which inevitably contribute to a favourable monetary and financial sector in Sri Lanka.
It is encouraging to see improving macroeconomic fundamentals in recent months. A current account surplus in the balance of payments owing to large inflows of remittances and tourist earnings of about 3 billion US dollars will ensure external financial stability. If Sri Lanka could implement the precise policies given in the Road Map, it would not be difficult to achieve a good fiscal position, low inflation, low interest rates, and a good balance of payments position. We should not hesitate to follow the best practices outlined in the Road Map.