Inflation may exceed 10%

Aggressive policy rate cut in May followed by a reduction of the Statutory Reserve Requirement (SRR) by commercial banks may insert inflationary pressure, pushing headline inflation even beyond 10 percent over the next 12 months, a local stockbrokerage warned.

“We expect the Central Bank of Sri Lanka (CBSL) to refrain from further loosening policies in 2013 in pursuit of stability in macro-economic variables,” said NDB Stockbrokers emphasizing on economic stability devoid of ad hoc changes.

Last week the monetary board decided to cut the SRR requirement by 200 basis points to an all time low 6 percent from 8 percent on all rupee denominated deposits of commercial banks.

This will release around Rs.45 billion of funds to the banking sector which otherwise would idle at the CBSL as required reserves.

However NDB Stockbrokers view this extra liquidity created in the banking sector by the Sri Lankan Rupee may propel demand for imports putting depreciating pressure on the Sri Lankan currency.

Meanwhile some analysts argue that while this extra liquidity might stimulate growth to a certain extent, this could back fire in the external front, widening trade deficits and weakening the rupee since the extra liquidity will be absorbed mostly by the import demand.

In April, the trade gap widened by almost 20 percent with imports increasing 5.7 percent. “While our expectation for LKR is to settle at 131 per US $ by end 2013, the current strengthening of US $ against most other currencies may depreciate the LKR against the US $ further,” NDB Stockbrokers forecasted.

In the recent past, CBSL’s monetary policy clearly demonstrated its biasness towards achieving projected growth numbers and came under heavy criticism by many quarters for putting growth before inflation.

However the CBSL boasts of maintaining the inflation at single digit level for the past four years although the headline inflation trended up towards upper single digits starting from March 2012 which peaked to 9.8 percent in January 2013 indicating a Rs.10 erosion of every Rs.100 income earned by the people.