Expectations of Foreign Inflows and Future of Monetary Policy
Features
In spite of 150 million dollar year to date foreign outflow from Sri Lankan equity markets, Central Bank
remains positive on expectations of a surplus inflow by year end. CB claims that with corporates and
banks set to raise capital abroad, about a billion dollars in equity and debt would flow in by 2011. This
expectation seems to be the only justification of facilitating eight percent economic growth by keeping
exchange rate and interest rates below the free market equilibrium range, aided by the delicate mix of
rising CB liabilities and its shrinking dollar reserves.
However, this expectation of Central Bank of arriving at a surplus inflow by year end does not necessarily
fall in line with regional trend in portfolio flows. The benchmark share indexes of regional markets have
shed base points significantly during the past month; Bangladesh is down 28.7 percent, Hong Kong down
22 percent, India down 19 percent so far this year. Further, the Indian Rupee, the South Korean Won and
the Thai Baht depreciated nearly 28 percent, 27 percent and 7 percent to USD respectively during the
course of last month.
This trend in investment flows across regional frontiers came to light as investor mind-set shifts from a
motive of multiplying earnings to guaranteeing safety of funds. The worsening economic outlook of
European region and United States compelled these high net worth individuals and funds to shift away
from emerging markets in Asia to the last resort safe haven: U.S government paper, despite the fact that
Asia is still all set to perform far better than any of the traditional super powers in world economy.
In this regional and global setting, monetary policy of Central Bank expecting foreign inflows to act as a
kind of a defence shield against major structural issues in the economy and depending on inflows to
shelter the growth process in a ‘post-war economy’, appears to be somewhat irrational and
unsustainable. We expect Sri Lanka’s current account deficit for 2011 to reach 5.6 percent of GDP, only
trailing by less than half a percent to the range which could trigger a flight of capital.
Under this backdrop, we do not expect the prevalent monetary stance of CB to remain unchanged
beyond the first quarter of 2012, and hence, interest rates are expected to receive a relative free hand
from CB till they reach a high, which reflects the equilibrium position of market conditions if exchange
rate remains unchanged.