Growth Now the Priority

Central Bank Governor Ajith Nivard Cabraal discusses the economic outlook, EPF returns and Greek bonds

By Shamindra Kulamannage.

Published on January 22, 2013 with No Comments

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Like for most businesses – which had only marginal profit growth – 2012 is a year the Central Bank will be glad to see the back of. An obstinate and failed dollar peg policy resulted in an unwieldy unravelling. Private firms that believed bank rhetoric that the peg could be maintained and didn’t cover their open foreign currency positions suffered for their misbegotten trust.With central bank reserves depleted, the government was forced to seek emergency IMF help.
The effects of economic shock therapy are now apparent. Growth has collapsed, inflation is stubbornly high and strictures imposed on banks prevented their funding businesses. Although the aftershocks of this crisis are still apparent, reserves are on a stronger footing after the Rupee was floated. The bank may now discuss with the Fund a new longer term loan supporting the government’s reform agenda. Central Bank Governor Ajith Nivard Cabraal discussed these and other more controversial issues during an interview. Excerpts…

The markets were surprised with your last rate cut, because inflation is still at 9% level. Can you explain the rationale behind that?
Our decisions are generated by the future outcomes that we are trying to fashion, and as a response to some of the threats that we would see. That’s the important factor that is sometimes missed by markets.
At the beginning of the year (2012), we took measures to achieve specific outcomes. We brought in a credit ceiling and some rate hikes. The government took steps to increase the duties of certain items to discourage imports and also introduced a more flexible exchange rate policy. All these were designed to bring certain stability by the end of the year, which of course, was going to be at the cost of some growth. By December though, almost all the outcomes that we wanted to achieve have come through, and we are satisfied.
The inflation we see today is not driven by demand; it’s driven by certain supply constraints. In that situation we don’t need to persist with a credit ceiling and we don’t need to keep a very tight monetary policy. Monetary policy was kept tight for a period of time and is now having the desired effect. There is space for us to now relax, and at the same time encourage growth to come back to normal steam once again.

So it looks like growth is the greater priority versus inflation for 2013. Is this correct?
The priority is the item which is at risk. Likewise, certain areas such as our BOP, import demand and overall current account surpluses had risk, so we addressed them. Once the risk is addressed you can then get back to your overall priority of your economy. As an overall priority of the economy we have growth, which is certainly at the forefront. But growth cannot be at the expense of the rest of the fundamentals.

Central Bank was forecasting much lower inflation by end 2012. However, it’s still stubbornly high. What would be the inflation target for next year?
We’ll end the year at about 7.5% average inflation, and that in today’s context, would be reasonable. We would have preferred to have it in the mid single digits, as we originally wanted to, but when you look at the adjustment that we have put in place in the economy, some increase in inflation is inevitable.
This inflation increase, we think is a reasonable price to have paid for all the other adjustments. Petrol prices were increased, we brought in an exchange rate policy which made the rupee depreciate and we introduced a credit ceiling. Then we had the drought which was a very serious one, and we had the oil prices which were extremely stubborn. Actually, we didn’t expect oil prices to remain at such high levels for the entirety of the year. But during this entire year oil prices have been north of 110 dollars, so it has been a very difficult year.

If inflation is the lesser of the risks, it must be possible for Sri Lanka to then grow faster in 2013. What is your take on this?
A: We have a 2016 goal of a 1000 billion dollar economy, 4000 dollars for per capita income, which we think is important for us to achieve. The platform we will create by the end of this year (2012) will be an extremely good one.
But, again we’ll have to be conscious of the outside environment and if we feel that the outside environment is extremely hostile, then we need to take a little bit of a cut back, which we are prepared to do and also have space to. We’ll probably grow ahead of 6% this year (2012), which is an extraordinary growth compared to the rest of the world, and also an extraordinary growth in the context of the adjustments that we have made to our economy. In that context, we will definitely have better growth next year, because we are poised for that.

Governor you have been quoted as saying that we may not go to the sovereign bond market in 2013. We have been doing that for 4 years consecutively. What is the impact of doing that on BOP and how are you visioning the management of that impact?
Next year (2013) we are not having any bonds coming up for payment, so the government does not have an additional need for a repayment. At the same time, government has made a decision that some of the funding required will not be directly funded through government borrowings alone. There are many banks that have developed capacity, and if they take on some of these projects as viable business projects, you will find that the overall discipline maintained will also be greater.
Bank of Ceylon has already raised a 500 million dollar bond and other banks are also poised to do that, and some of the key mega projects can be funded directly by banks. This eases the burden on the government as well and that’s the position that we have placed ourselves in now.

There’s been news that Sri Lanka is talking to the IMF about the Extended Fund Facility. We’ve seen in lending to Europe that the IMF’s role has slightly changed. They have been funding budget deficits, which is not the role the fund was set up for. Is Sri Lanka considering similar options?
The original reasons that were valid at the time we went to the IMF are no longer criteria. We don’t have a balance of payments difficulty. When we discuss with them next, we will first look at whether we need it, if we need it, what is the instrument that we are going to use, and if we use that instrument, how will we fashion the program. We will also have to see that the interest of the country is ensured. There is going to be a discussion certainly, and we will explore whatever options are available.

So a loan supporting the budget is also an option?
It’s not a factor we are looking at, because the budget deficit has been coming down, and if we could have funded a 8% budget deficit without the IMF, this year (2012) will probably be close to a 6.2%, so it’s unlikely we would need support of that nature. But, if it is coming at a level or a rate at which it is attractive, we will certainly look at it as an option.

IMF funds come at attractive rates.
The rate itself may not be the only factor. There will be other factors that we will have to take into consideration. If we find those are also attractive, then it can be considered, but certainly government also has so many other options. Going to the markets is one option, and every time Sri Lanka has gone to the markets, the markets have been very bullish.

While the deficit has been declining there are challenges with some state managed institutions. CPC, CEB and Sri Lankan Airlines are perhaps the largest of them. You as governor manage monetary policy, but obviously monetary policy doesn’t operate in a vacuum. Are you worried next year (2013) will be a challenging one for the state institutions and that may ricochet on what you do?
Our business is also to establish and maintain stability. If you are looking at economic and price stability or financial systems stability, in certain instances we may need to take decisions in a judicious manner.
If the prices of fuel rise, and we are not sensitive to the fact that there are a large number of industries that depend on fuel to generate electricity, and if we without any reference whatsoever make those adjustments, the shock that it creates for the economy can be very severe. So, we are sympathetic to certain decisions being taken over a staggered period of time, but at the same time, we have always maintained that even in the midst of these high prices, there has to be that adjustment taking place.

If you are anticipating lower inflation next year (2013), do you think it will be a year where a substantial amount of adjustment can be made?
That’s a call that they have to take. It all depends on how much you can tolerate, how much is needed, and whether the adjustment is taking place with other factors as well. Right now, the rains have come, and the electricity mix is completely changed. There was the drought in September, we had only about 8% or 9% of electricity being generated with water, today it has gone up to 60%, so the dependence on oil is much less. Like that, there are certain factors that work for you and sometimes against you.

The EPF annual report for 2011, which is a fund managed by the Central Bank’s monetary board, has not been published – what is holding it back?
There is absolutely no delay on the part of the monetary board. I can tell you that, all the data that we should have furnished have been provided.
This is a politician who is screaming his head off as usual, which has absolutely no bearing on the actual facts, and they have misled the people. Parliament has been kept notified, that is our responsibility to do so, and it has been done.

The delay is now inordinate?
There is no delay on our part, if you look at the obligations of the EPF according to the Act, all these have been adhered to. So, these inordinate delays are certainly out of the question.

But it hasn’t been published yet?
It had been published, it had been published in the newspapers also.The Annual report will be published at the right time, after the audits have been completed and audit reports come in. After it has been given to the auditors, I can’t go and ask the Auditor General to give it at the time I want. That is their call. We have submitted it at the right time, after that if the MP’s have a problem they can ask the auditor general, but they won’t do that. They will write to the newspapers, that is what’s happening. Then you’ll also pick it up, without checking what the exact situation is.

Which is why I am checking with you.
Very good, I’m glad that you’re doing it at this stage, because this is the situation. We have enough people who know these subjects and they have done it right all the time.

There are concerns speculative stocks have been purchased by the EPF, which have lost value. Can you give us some idea about the performance of the equity portfolio?
The rationale we have always maintained is that it is a long term investment, and if you look at every portfolio of every institution including the unit trusts, they have also lost value. Check it out because it is in our medium term report. Not only the EPF, but every single private sector driven unit trust has also had their portfolios reduced.

In fact a lot of unit trusts reduced their equity exposure from about 60% of all funds managed to about 35% at a time EPF was increasing equity exposure.
But they have lost value.

They liquidated substantial parts of their portfolios before the crash.
They may give you any excuse they like, but they liquidated at a loss.

No they liquidated mostly at the peak, if you really look at the reports.
How did their value reduce then? Check the reports, you all don’t do that. It is reported in our half year report. They have all lost value, but not one single word has been mentioned about that. When you invest in a portfolio what you do is, you invest as an overall total. I have seen some of the reports that you all turned out. When there is a particular company which has made a loss then you’ll highlight that, but when there is huge profit in certain other companies that the EPF has also got very high stakes in, then not a word. I see that as very selective reporting, which is very unfortunate.

I don’t think in public there is a criticism of all equity investment. But there are concerns about some of the companies.
Maybe, but when it starts doing well. What will be the situation?

Unit trusts were risk averse and lost less.
If anyone is willing to come and say that the EPF portfolio will not have value in five years time, we are willing to take them on. But I don’t think they will do that, they will only speak at the time when it has lost value.
Have you ever heard anybody saying that the EPF portfolio had a 19 billion surplus at one time? Are you willing to challenge that? Did any one of these fellows talk about it? Why? That is because they are selective. That is because they only want to come up with some criticism at a time when it is not doing so well. But they will dare not open their mouths at other times. We are confident that our portfolio will do well. I know there’s a huge conspiracy by some people who want to take this out and hand it over to a unit trust. That is why it is also being highlighted. This is an orchestrated effort but we will not allow that to happen.
We are going to see them with their faces on the ground once the market also picks up. They tried every trick in the book. I know the way these people operate.

Reserves were invested in Greek bonds, a very risky thing to have been done?
Which central bank has made the highest return in the whole of last year? It is the central bank of Sri Lanka that had a 6.6% return. I think that has been again politically motivated. If you look at the overall performance of our team, it is the best in the world. But, traditionally our approach has also been one of caution with reserves, surely there are many options. Surely, you want to make a return also. In all other central banks they are making 2%, why doesn’t anybody talk about it. Are you all allergic to saying that the central bank had done brilliantly, by getting a return of 6.6%. Why don’t you’ll say that?
I have not heard you’ll say that, please say it. Open your mouths and say it. Governor your team has returned 6.6% which is the best in the world, why are you all reluctant to say that?

The higher the return the greater the risk, isn’t it?
Why are you worried about that? Why are you not able to see that every year we have performed better, that our reserves have not lost value?

There are plenty of speculative grade bonds offering high returns
If they are, then why aren’t the other central banks making that?

Because they are not rated highly enough.
Whatever you may say they have been generating 2% or 1%. You all don’t have the ability to acknowledge that your central bank has been able to give a higher return, to be very frank I am very sad to see that, because you are harping on one or two things, but you are unable to open your mouth and say governor you have done a great thing by achieving this return.

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