Press Release No. 11/325

Press Release No. 11/325
September 7, 2011

A staff mission led by Brian Aitken visited Colombo August 29 – September 7 to conduct discussions for the seventh review of the Stand-By Arrangement. The team met with government and Central Bank officials, as well as representatives of civil society and the private sector. The mission issued the following statement today at the conclusion of its visit:

“Macroeconomic conditions remain satisfactory. The economy is expanding rapidly, with growth likely to come in around 7½ percent this year. As expected, headline inflation has moderated, reflecting declines in food and commodity prices, and there are as yet no clear signs of economic overheating.

“The overall monetary policy stance thus appears appropriate. Nonetheless, sustained rapid credit growth bears close monitoring and may need to be slowed in order to prevent future inflationary pressure. Banks and other financial institutions should also guard against a relaxation of lending standards and the accompanying risk of a build-up of nonperforming loans.

“Fiscal performance has been satisfactory and the government’s 2011 deficit target is still within reach. The government is now preparing its 2012 budget and remains committed to continue with recent trends toward fiscal consolidation. The state energy enterprises’ recent performance, however, remains a concern. Given the lack of rains and high international oil prices, current policies would result in financial losses at the Ceylon Electricity Board (CEB) and Ceylon Petroleum Corporation (CPC) this year.

“The uncertain global environment underscores the importance of continuing to build foreign exchange reserves. While headline reserves are at a comfortable level, buoyed by the Central Bank’s purchase of the proceeds from the recent 10-year Eurobond, nonborrowed reserves—that is, excluding Eurobonds, IMF disbursements, and foreign holdings of Treasuries—have steadily declined, reflecting foreign exchange sales by the Central Bank. This policy does not seem to be in line with the current fundamentals of the economy. In responding to market pressures, the Central Bank should henceforth limit its intervention and allow more exchange rate flexibility. Flexibility in the exchange rate, which has appreciated substantially in real terms over the past two years, is also an essential component in ensuring Sri Lanka’s export competitiveness.

“The team will return to Washington and continue to assess policy actions and economic developments and looks forward to continuing discussions during the Annual Meetings of the International Monetary Fund and World Bank Group in Washington.”