COLOMBO (News 1st) – Sri Lanka’s economy, which has faced extreme headwinds and heightened uncertainty in the first half of 2022, has shown signs of stability in the second half so far, helped by the myriad of multi-faceted policy interventions undertaken to steer the economy towards a transition to a medium-term stable and sustainable growth path, the Central Bank of Sri Lanka said on Wednesday (9).
CBSL made the announcement via the publication “Recent Economic Developments: Highlights of 2022 and Outlook for 2023”.
He also said that engagement with the IMF on a macroeconomic adjustment program had progressed on many fronts, with a service-level agreement for an EFF concluded in early September 2022. The debt restructuring process has also reached an advanced stage. Sri Lanka’s economic problems are summed up in deep-rooted structural weaknesses that culminate in the lack of commitment from policy makers to undertake comprehensive and effective long-term reforms.
The IMF’s EFF program will provide an opportunity to embark on much-needed and long-neglected structural adjustments in a more structured and timely manner, which will help shape the economy to move forward on a path of greater stability and growth. supported. Nevertheless, the expected short-term recovery of the economy is facing many challenges due to the unprecedented scale of the crisis facing the economy and the uncertainties on several fronts which could require rapid policy actions to as circumstances evolve, the central bank said.
Amid significant economic challenges on the home front, the economy will also have to contend with global uncertainties stemming from monetary policy tightening measures adopted by major central banks in response to soaring inflation, contagion effects geopolitical tensions and hence to a looming global crisis. recession, which will make the external environment less conducive
for economic recovery.
Considering the progress made so far on the IMF-EFF program and debt restructuring negotiations, as well as the reforms already undertaken and those to be implemented in the coming period, the he economy is expected to shift to the path to recovery from the end of 2023. Nonetheless, this will depend on the unwavering commitment of policy makers to implement policy reforms in a timely, holistic and effective manner while ensuring that this commitment is not hampered by political and electoral cycles.
This is imperative to avoid any oscillation of national policies in the crucial period ahead in order to strengthen the resilience of the economy to external shocks, thus ensuring its unwavering progress in the medium term.
Although the economy is on the road to recovery after the easing of the COVID-19 pandemic, its progress has been dampened by the culmination of twin deficits rooted in the state budget and the external current account, the central bank said.
Thus, the growth momentum observed towards the end of 2021 quickly dissipated and the real economy entered into contraction during the first half of 2022, under the effect of the fallout from the unprecedented economic crisis felt in several sectors, due to fuel shortages, blackouts, widespread scarcity of major imported raw materials and other essential products, and soaring production costs, among other factors.
The steady rise in inflation to historically high levels since the start of the year has increased household purchasing power. This abnormal rise in inflation stemmed from disruptions in domestic and global supply, the implementation of long overdue adjustments in administrative prices, the sharp depreciation of the Sri Lankan rupee against the US dollar and the release of pent-up demand pressures emanating from the lagged impact of currency changes. accommodation in the recent past.
Moreover, the expansionary fiscal policy with the low fiscal regime introduced at the end of 2019 fueled inflation, not only by directly improving aggregate demand, but also by requiring monetary financing to fill the growing fiscal deficit in a context of lack of access to international capital markets following rating downgrades. .
Monetary tightening efforts, which began in August 2021, have accelerated so far in 2022 to avoid a possible unanchoring of inflationary expectations and halt lingering demand-driven pressures. Supported by these measures and the easing of supply-side pressures, inflation started to moderate along the disinflation path envisaged in October 2022.
At the same time, the transmission of monetary tightening measures, coupled with still tight money market liquidity conditions, led to sharp upward adjustments in market interest rates, resulting in a substantial decline in credit to the sector. private. Nevertheless, the net credit of the banking system to the State has increased, particularly in a context of low public revenues and limited access to foreign sources of financing.
Broad money (M2b) growth, once corrected for the impact of the rupiah depreciation, has decelerated from its peak in April 2022, mainly due to the credit crunch in the private sector and the decline in the net foreign assets of the banking system.
During the year, external debt servicing became increasingly difficult, given the lack of access to international markets due to consecutive sovereign debt downgrades and the accumulation of large payments to the external debt service headline amid lackluster foreign exchange inflows. Due consideration of these difficult circumstances, the government announced a freeze on external debt service on bilateral and commercial loans for an interim period beginning April 12, 2022.
In the ensuing period, with the aim of helping the economy return to a stable and more sustainable footing, the government launched a reform program by introducing a series of measures aimed at increasing tax and non-tax revenue, while by continuing to further rationalize expenditure by reducing non-emergency capital expenditure and operating expenditure. In addition, the government has chosen to seek financial assistance from the IMF under an EFF arrangement.
However, the overstretched fiscal position, which is already weighed down by soaring debt, provided little fiscal space to take measures that could catalyze the process of economic recovery. The external sector also continued to face heightened challenges due to the shortage of liquidity in the domestic foreign exchange market.
Despite the moderation in import demand and the announcement of the debt moratorium, modest inflows into the current and financial accounts were not enough to contain the pressures on the exchange rate.
The external current account deficit widened in the first half of 2022, compared to the same period in 2021. The trade deficit narrowed due to moderation in imports, mainly due to import controls
measures, the lack of foreign exchange available on the market, the depreciation of the exchange rate, the tightening of monetary conditions and the robustness of exports. Tourism revenues have shown some recovery, while workers’ remittances have remained weak despite some recovery in recent months.
Increased pressures on the exchange rate necessitated a measured adjustment, which was authorized on March 7, 2022. However, weak liquidity conditions in the domestic foreign exchange market and unfavorable market perceptions caused the exchange rate to depreciate. stronger than expected. With a view to reducing excessive and speculative volatilities in the intraday exchange rate, the Central Bank has started providing guidance to the market by announcing an average rate and a range of variation of the weighted average interbank spot exchange rate from May 13. 2022.
This helped to further restore exchange rate stability and minimize the gap between official and gray market exchange rates.