Sri Lanka economy now undergoes a monetary policy easing cycle.
By: Staff Writer
January 27, Colombo (LNW): As the economy undergoes a monetary policy easing cycle, the credit cycle is expected to enter an expansionary phase, in which macroprudential concerns could build-up.
The Central Bank commits to monitoring these developments closely and implementing necessary policy actions to mitigate systemic risks and ensure financial stability through macroprudential interventions., CB Governor Nandalal Weerasnghe said.
The easing of domestic monetary policy since mid-2023, is anticipated to facilitate the recovery in financial intermediation, which was witnessed through the gradual recovery in banking sector credit during Q3 of 2023.
This is expected to lead to a rebound in domestic demand and economic activity as witnessed through the modest economic growth recorded in Q3 of 2023, improving income levels and alleviating pressure on the balance sheets of households and firms.
Moreover, targeted stabilisation of domestic inflation at 5 per cent in the medium term is expected to enhance the purchasing power of economic agents and improve their debt repayment capacities.
Efforts are underway to address the Sovereign-Bank Nexus4 through policy reforms, aiming to rectify financial intermediation imbalances in the medium to long run.
Recent positive developments, such as reaching an agreement in principle with the Official Creditor Committee (OCC) and the Exim Bank of China, contribute to the stability in the Government securities market.
The anticipated conclusion of External Debt Restructuring (EDR) is expected to further enhance stability.
Efforts are also required to improve sustainable foreign currency inflows to prevent external sector imbalances along with prudent measures towards risk mitigation by the financial sector.
Moreover, banks are expected to strengthen their capital buffers, considering the potential losses which may arise from debt restructuring, results of the bank diagnostic exercise, and realisation of forward-looking impact assessment.
Although it is expected that the existing macro-financial vulnerabilities would dissipate in the period ahead, with the envisaged improvements in the macroeconomic front, continued advancement along the policy reforms agenda envisaged in the IMF-EFF agreement is essential, particularly in the fiscal front to direct the economy and the financial system into stable grounds.
Any deviation from this path would bring detrimental and irreversible consequences to the financial system and the economy, though moving along this arduous and narrow path is challenging.
The instigation and operationalisation of strong and appropriate frameworks that proactively address vulnerabilities and implementation of timely, well sequenced, and consistent policies is also crucial to ensure the stability of the Sri Lankan financial system.