Core inflation moves up

* Headline inflation impacted by rising food prices
* Questions remain on monetary policy easing

December 2, 2012, 7:52 pm

Core inflation, which excludes food and fuel prices, has increased in November the Central Bank said.

Core inflation is used to gauge underlying price movements in an economy with food, fuel and other sensitive items being excluded from the index although some economists argue that core inflation is not an accurate measure of price movements because it leaves out food and fuels.

Core inflation in Sri Lanka has increased both on an year-on-year and annual average basis to 7.2 per cent and 5.6 per cent respectively in November 2012, the Central Bank said, from 6.8 per cent and 5.4 per cent respectively the previous month.

Meanwhile, headline inflation increased due to increases in food prices.

"Inflation, as measured by the Colombo Consumers’ Price Index (CCPI) (2006/07*100) computed by the Department of Census and Statistics, increased to 9.5 per cent in November 2012 on a year-on-year basis from 8.9 per cent in the previous month mainly due to the increase in food prices. Moreover, the inflation rate on an annual average basis increased to 7.2 per cent in November 2012 from 6.8 per cent in October 2012," the Central Bank said.

"The CCPI increased by 1.3 per cent in November 2012 over the previous month, with the Index increasing in absolute terms to 167.1 from 165.0 in October 2012. The contribution to the monthly increase in the Index came mainly from price increases in the Food category (by 2.4 per cent).

"The prices of many varieties of vegetables, red onions, big onions, potatoes, coconuts, wheat flour and bread increased during the month. However, a decrease in the prices of eggs and some varieties of fresh fish, dried fish and fruits was reported.

"Within the Non-Food category, prices increased in the sub-categories of Clothing and Footwear (by 0.4 per cent); Housing, Water, Electricity, Gas and Other Fuels (by 0.4 per cent); Furnishing, Household Equipment and Routine Household Maintenance (by 1.0 per cent); Transport (by 0.2 per cent) and Miscellaneous Goods and Services (by 0.4 per cent).

"Meanwhile, the prices in the sub-categories of Health; Communication; Recreation and Culture; and Education were unchanged during the month," the Central Bank said.

Market interest rates continued to be high and analysts said the Central Bank could reduce policy interest rates from their current level of 7.75/9.75 if inflation moderates next year. However, the government’s domestic borrowings would also impact on domestic interest rates.

The average weighted prime lending rate of the domestic banking system reached 14.15 percent last week, up from 9.83 percent a year earlier. This rate applies to high net worth individuals and institutions. The average weighted lending rate stood at 15.38 percent as at end September (latest available), up from 13.62 percent a year ago.

"In 2013, the (monetary) policy focus is likely to shift to supporting growth from tracking high inflation and credit growth," Standard Chartered Bank said in a recent report.

"The most recent central bank statement expressed a clear intent to ease monetary policy given that credit growth has slowed, the trade balance has improved and inflation is expected to moderate by the second quarter of 2013. We think this will the give the central bank sufficient room to cut monetary policy rates by 25 basis points in the first quarter of 2013," it said.

However, economists have cautioned that the government’s spending pattern would determine monetary policy direction.

"Non bank borrowings will be high next year. This means more funds would be mobilised by selling Treasury bills and bonds to the public and borrowing from EPF, NSB and Sri Lanka Insurance," Institute of Policy Studies Executive Director Dr. Saman Kelegama told a recent forum.

"For such borrowings to be effective interest rates would have to be attractive and this, among other factors, implies there is limited space for a reduction in policy interest rates," he said.

According to 2013 budget proposals the government will not seek foreign commercial loans next year after borrowing Rs. 109.5 billion in 2011 and Rs. 128 billion in 2012.

With the budget deficit estimated at Rs. 507.4 billion next year, the government hopes to raise Rs. 86 billion from foreign sources to finance the deficit, a sharp decline from Rs. 205.6 billion estimated for this year, while domestic borrowings are estimated at Rs. 421.4 billion, almost doubling from 259.6 billion in 2012.

Non bank domestic borrowings are expected to carry the weight of the deficit, surging to Rs. 289.4 billion next year from 84.6 billion this year.

The Central Bank is concerned as well.

"The expansion of credit to the public sector, which includes the government and public corporations remains a concern. Being less sensitive to changes in interest rates, net credit to government depends on the budget deficit and the government’s strategy to finance the deficit, while credit to public corporations depends mainly on the operational losses they incur," the Central Bank said in its recent report ‘Recent Economic Developments: Highlights of 2012, Prospects for 2013’ released earlier this month.

"It is essential that public sector borrowing from the banking sector is restricted to the budgeted levels, in order for the monetary authority to maintain monetary expansion at the targeted level, which is essential for the success of monetary policy implementation," the bank said.