Road Map: Monetary and Financial Sector Policies for 2017 and Beyond Delivered by Dr. Indrajit Coomaraswamy Governor Central Bank of Sri Lanka 3 January 2017 1. Introduction Your Excellencies, Members of the So, let me warmly welcome you to the Monetary Board, Deputy Governors and presentation of this year’s Road Map. Officials of the Central Bank, Distinguished Invitees, Ladies and Gentlemen, Ladies and Gentlemen, as you aware, the core objectives of the Central Bank are the attainment of economic and price The presentation of the Road Map is a stability and the maintenance of very important tradition that was financial system stability with a view to initiated by the Central Bank in 2007 and encouraging and promoting the this is the 10th statement in that tradition development of productive resources of that we are presenting today. It is our Sri Lanka. We attach the highest priority belief that sharing our policy direction to delivering collectively on the would make our policies for the medium- mandates given to us. The considerable term more predictable and transparent, resources of the Central Bank of Sri and would help you in shaping your own Lanka are focused on achieving these plans and operational modalities in the objectives on a sustained basis and on future. It will also ensure greater clarity performing the important agency and regarding our policies and actions. ancillary functions bestowed upon us In this context, we believe that effectively. harmonisation of purpose and better During 2016, we have implemented coordination among private sector and several proactive policy measures in public sector operations would enhance order to ensure economic and price the effective implementation of our stability. These policies have helped curb policies and measures, thereby helping demand pressures in the economy and to achieve our common development maintain inflation at a low level. At the goals. same time, we have introduced several policies related to the financial sector with the view of strengthening Central Bank of Sri Lanka – ROAD MAP 2017 institutions and ensuring effective and to strengthen the delivery of credit to active markets as well as safe and sound the agriculture sector and to small and payment mechanisms. medium scale enterprises as well as the In addition to our core functions related to the key objectives I have just outlined, we have performed a number of agency and ancillary functions, thus contributing to enhance the overall performance of the economy. The Central Bank manages the Public Debt to ensure that the government's financing needs and its payment obligations are met at the lowest possible cost over the medium- to longterm, consistent with a prudent degree of risk. The Exchange Control Department also initiated a number of measures in order to create a more conducive environment for both local microfinance sector, thus facilitating greater financial inclusion. Also, as the sole authority for issuing currency, the Bank has continued to ensure that all cash transactions take place smoothly. We consider that communication is an integral part in pursuing policy actions and discharging our responsibilities. Considering the utmost importance of clear communication and enhanced transparency, we attach priority to formulating our policies in a forward looking manner, which will help economic agents to make their economic decisions in a more informed manner. and foreign investors. The new Foreign Ladies and Gentlemen, today, we are Exchange Act is designed to effect living in a challenging world. Sri Lanka is further improvements in this regard. A gradually transforming to an upper number of measures will be taken in the middle income economy. However, the medium term to further relax foreign objectives of the government and the exchange transactions. The Central Bank aspirations of the people cannot be met is also the manager of the Employees’ through “business as usual” on the part Provident Fund, which is the largest of the public and private sectors. superannuation fund in the country. Government policy making needs to be Through the activities of the Regional proactive. It has to be more data driven Development Department and the and less influenced by short-term provincial offices, the Central Bank seeks political expedience. Equally, the private Central Bank of Sri Lanka – ROAD MAP 2017 sector needs to recalibrate its risk When we review Sri Lanka’s post- appetite and take advantage of independence economic performance, it opportunities generated by improving is clear we could have done better. In macroeconomic policies and a more the Central Bank’s context, the conducive, enabling environment for perennial excess aggregate demand in business. We would all like progress to the economy, created by large fiscal be faster but the direction of travel is deficits, has complicated monetary and clearly positive. There is also the exchange rate policies. likelihood that, as the reforms gain momentum, the pace of change will accelerate, provided there is the commitment to persist with the measures that are necessary to place the economy on a higher trajectory of growth, employment generation and incomes. As the Central Bank, we have a pivotal role to play while being at the heart of this much needed transformation. The government is putting forward many new initiatives to develop the country. This is happening at a time when the global economy is undergoing yet another transitional period. Hence, this is truly a challenging time, which calls us to be proactive and focused on clear outcomes. However, I believe Sri Lanka now faces one of its best chances since independence, to correct this situation. In particular, the country does not have a drag in terms of an internal conflict or regressive policies. Today, Sri Lanka is poised for a fresh leap of development. In that context, it is the responsibility of the Central Bank to provide a stable foundation to leverage the country’s excellent geographical location and favourable international relations to attract investment to foster more robust and sustainable growth and employment generation. Sri Lanka is twenty miles from the fastest growing large economy, India; in the middle of China’s Maritime Silk Route; and fortunate to have At this juncture, I would like to share excellent relations with a number of some of my thoughts on the Sri Lankan capital surplus countries in the world. economy in a broader perspective. Central Bank of Sri Lanka – ROAD MAP 2017 As I have repeatedly emphasised, We have to establish a solid foundation sustained growth requires for the nation to meet the imperatives of strengthening macroeconomic a new economic growth model, built on fundamentals, implementing structural the core tenets of high value-added reforms that increase the entrepreneurship, creativity and competitiveness of the economy, and innovation to generate benefits for all improving the business environment. Sri Lankans. The challenge that we are having right The country has a number of structural now is to put in place policies that give problems that have been amplified over us sustained stabilisation of the years by the large fiscal and trade macroeconomic fundamentals in the deficits, which are the core weaknesses country, amidst uncertain global of the Sri Lankan economy. Being a twin conditions. deficit country increases vulnerability in It is important to recognise that stabilising the economy after decades of an uncertain and volatile global economic environment. fundamentally unstable macroeconomic Unsustainable budget deficits boost policies cannot be achieved without excess and untenable demand in the discipline. This will inevitably result in economy. When there is excess demand, some pain in the short-term. However, it leads to inflationary pressures and there is every possibility that a more higher nominal interest rates in the promising future can be realised economy and there is also a higher through the policies and programmes propensity to import, given the that are already in the pipeline. For this limitations in domestic supply. That in to happen, consensus must be built turn, exerts pressure on the balance of among politicians, policy makers and payments and the exchange rate. the general public on the need for cohesive reforms around the three pillars of robust macroeconomic fundamentals, improving productivity/competitiveness and the improved business environment. Central Bank of Sri Lanka – ROAD MAP 2017 This has been the Sri Lankan experience over several decades, which stands in marked contrast to the policies of the successful East and South East Asian countries. Those countries achieved robust fiscal outcomes, low inflation, encouraging that it has commenced. low interest rates and competitive The International Monetary Fund (IMF) exchange rates. itself has recognised that progress has We cannot continue with repeating stopgo cycles, with each successive trough becoming more dangerous. We have to change with vigour in order to achieve our objectives. We have missed enough opportunities and we cannot afford to miss them repeatedly. We need decisive policy initiatives implemented with commitment. More importantly, we need to take a longer term view and act accordingly. It is naïve to believe economics can be separated from politics. No country, no society has been able to achieve this. However, we need to ask why Sri Lanka, which was second to Japan in Asia, on most socio-economic indicators, has slipped so far behind today. been made in stabilising the economy. Improved fiscal performance has been at the heart of this improvement. Honourable Finance Minister and his team deserve credit for this. However, the continuing challenge is to have the clarity of purpose, focus and determination to implement the necessary changes. It has to be a national effort. The potential for accelerated development is clearly evident. The government’s plans, programmes and projects, as set out in the Honourable Prime Minister’s Statement and the Budget Speech have sign-posted the way ahead. However, the task now is to continue to turn the good intentions into reality. This journey ahead also We need to ask why this is. In what is requires a rebalancing of economics and often termed the Asian century, Sri politics in economic decision-making, if Lanka is the only country, other than we are to stay on course. Afghanistan, in the Asia/Pacific region with an IMF programme – having an IMF programme is the economic equivalent to being in hospital. We are not in the The government has commenced a strong revenue-based fiscal consolidation programme. ICU but clearly in hospital. The remedial treatment is known and it is Central Bank of Sri Lanka – ROAD MAP 2017 Trade and investment policies are also  Section 2: Review of the being changed to harness our untapped developments in the economy along potential. with the progress in the real, fiscal, We at the Central Bank, are changing and upgrading many of our processes and policies. Frameworks are being developed for proactive monetary and exchange rate policymaking on a data driven basis. In this context, the Road Map 2017 reviews developments in the economy and the policy actions that have been pursued during the past year. More external, monetary and financial sectors during 2016  Section 3: An analysis of the Central Bank’s monetary policy strategy and policies for 2017 and beyond  Section 4: A discussion on the Central Bank’s policies related to the financial sector performance and stability in 2017 and beyond  Section 5: Key policies related to importantly, it seeks to enunciate strengthening the broader economy policies and programmes for the through the Central Bank’s agency forthcoming period. and ancillary functions Accordingly, the outline of the Road  Section 6: Concluding remarks Map 2017 is as follows: Central Bank of Sri Lanka – ROAD MAP 2017 2. Developments in the Economy in 2016 The Sri Lankan economy achieved a Inflation continued to remain at low moderate growth rate of 4 per cent levels although there were some upward during the first nine months of 2016. pressures during 2016. Supply side Among major sectors, Agricultural pressures due to adverse weather activities remained subdued, driven conditions and revisions to the mainly by the contraction in the value government tax policy partly addition of rice, tea and rubber. Adverse contributed to the increase in inflation weather conditions during the second during the year. The relaxed monetary and third quarters of the year and policy stance pursued in the past and the subdued demand conditions in the major increase in wages in the economy also export destinations affected this exerted some demand pressures on growth. Industry-related activities grew prices. Accordingly, headline inflation, as substantially in 2016 with considerable measured by the year-on-year change in contribution from the recovery of the the Colombo Consumers’ Price Index construction sector. Notable growth (CCPI, 2006/07=100), was 4.1 per cent in was also witnessed in manufacturing, December 2016 compared to 2.8 per and mining and quarrying activities. cent in December 2015. Headline Meanwhile, the growth in Services inflation, as measured by the year-on activities also remained buoyant, year change in the National Consumer supported by improvements in financial Price Index (NCPI, 2013=100), was 4.1 per services, and wholesale and retail trade cent in November 2016 compared to 4.2 activities. Based on these developments per cent at end 2015. Accordingly, overall so far, it is projected that the economy inflation has been contained within our would grow by around 4.5 – 5.0 per cent mid-single figure target of 4 – 6 per cent. in 2016. We anticipate a growth of Meanwhile, core inflation continued its 5.5 – 6.0 per cent in 2017. upward trend in 2016, reflecting the firming up of demand conditions in the Central Bank of Sri Lanka – ROAD MAP 2017 economy and the revisions made to the eleven months of 2016, an increase of tax structure in the latter part of the 14.7 per cent over the previous year. year. Core inflation, based on CCPI, Workers’ remittances recorded a increased to 6.3 per cent, year-on-year, moderate growth of 3.1 per cent during at end 2016 in comparison to 4.5 per the first eleven months of 2016 and cent at end 2015, while NCPI based core amounted to around US dollars 6.6 inflation was 6.8 per cent, year-on-year, billion. With these developments, there in November 2016. was a narrowing of the savings – In response to preemptive monetary policy measures, monetary aggregates, which expanded at a high rate, decelerated, while growth of credit to the private sector showed some slowdown, mainly reflecting the impact of increased market interest rates. investment gap as reflected in the lower current account deficit during the first nine months of 2016. Foreign investment in the government securities market saw a net outflow, while longterm loans to the government recorded a net inflow. Meanwhile, during 2016, Sri Lanka entered into a three year Sri Lanka's external trade performance Extended Fund Facility (EFF) of SDR 1.1 was modest during 2016, although some billion (approximately US dollars 1.5 improvement was observed towards the billion) with the IMF to strengthen the latter part of the year. Earnings from external position of the country and to exports declined by 2.6 per cent during support the government’s broad the first ten months of 2016, while the economic reform agenda. Reflecting expenditure on imports increased these developments, the level of gross marginally by 0.2 per cent. As a result, official reserves is estimated to be the cumulative deficit in the trade around US dollars 6.0 billion by end 2016. account increased by 3.7 per cent to US Moreover, despite considerable dollars 7.2 billion during the first ten depreciation pressure on the rupee months of 2016. Supporting the external during some months, the rupee sector, earnings from tourism is remained relatively stable in 2016 estimated to have increased to around compared to the previous year. It has US dollars 3.0 billion during the first Central Bank of Sri Lanka – ROAD MAP 2017 depreciated by 3.8 per cent during the During 2016, several policy measures year. were implemented by the Central Bank, Fiscal policy in 2016 has been directed towards strengthening the fiscal consolidation process. Reflecting the positive impact of the strenuous efforts of the government, fiscal performance has indicated an improvement during 2016. Government revenue has continued its increasing trend while in line with international standards and best practices, to strengthen the regulatory and supervisory framework pertaining to licensed banks. Key banking sector indicators remained at healthy levels, while the nonbank sector performed despite stringent fiscal and macroprudential measures. maintaining expenditure at the desired Meanwhile, the national payment level. The government is certain that the systems of the country operated announced budget deficit of 5.4 per cent smoothly without any major disruption of GDP will be achieved in 2016, and it while facilitating the growing and will be reduced further to 4.6 per cent in changing payment needs of the financial 2017. sector with improved efficiency and safety. Central Bank of Sri Lanka – ROAD MAP 2017 3. Monetary Policy Strategy and Policies for 2017 and Beyond A coherent and clear macroeconomic macroeconomic policy framework in framework, is important to achieve our the country, built upon three key areas. objectives. The government is in the process of Among the key elements of the overall taking decisive measures to address the macroeconomic framework, price long felt deficiencies in its budgetary stability is an important pillar. Price operations through a new fiscal stability is interpreted to mean low, framework, aimed at strengthening stable and predictable levels of inflation, fiscal sustainability in the medium-term. which is conducive for fostering This framework is embedded in the IMF- sustainable long-term economic growth EFF arrangement. and employment in a country. Price stability is instrumental in keeping nominal interest rates low, thereby enabling an economy to exploit its growth potential, while both consumers and producers can make economic decisions with confidence and certainty. These efforts will complement the expected improvements of the Central Bank with regard to two key policy frameworks in relation to monetary policy. a. The conduct of monetary policy will Therefore, modern central banks be strengthened through the move predominantly focus on achieving price towards a flexible inflation targeting stability as a pre-condition for (FIT) framework. sustainable growth. b. A properly designed and widely In this context, I would like to indicate accepted framework for exchange that the Central Bank and the rate management will also be government are working towards introduced to establish a market- establishing a well-designed based exchange rate system in the country. Central Bank of Sri Lanka – ROAD MAP 2017 The broad-based reform actions under towards new frameworks, such as the EFF arrangement with the IMF will inflation targeting. complement these efforts. In line with this global tendency, the The Central Bank, since the 1980s, has Central Bank of Sri Lanka has also been been pursuing monetary targeting (MT) improving its monetary policy as its monetary policy framework to framework over the years. achieve price stability. Under this framework, monetary aggregates were used as a key nominal anchor in the conduct of monetary policy and the final objective of price stability was expected to be achieved by influencing money In particular, the Central Bank has officially announced that the monetary targeting framework would be gradually replaced by migrating towards a flexible inflation targeting framework. aggregates. Reserve money was Under this enhanced monetary policy considered the operating target and framework, the Central Bank would broad money was used as the focus on stabilising inflation in mid- intermediate target of monetary policy single digits over the medium-term, under this framework. while supporting growth objectives and Nevertheless, monetary targeting has flexibility in exchange rate management. become a less meaningful framework for Generally, an inflation targeting monetary policy conduct, given issues framework is characterised by an such as the instability in the money announced numerical inflation target, a demand function amidst financial medium-term inflation forecast, which innovations and the weakening facilitates forward looking monetary relationship between money and policy decision making and a higher inflation. degree of transparency and Hence, countries, which were accountability. dependent on monetary targeting Inflation targeting is known to be frameworks, have been moving away operationally complex. It requires greater awareness of the whole Central Bank of Sri Lanka – ROAD MAP 2017 monetary transmission mechanism upgrade the technical capabilities of the (MTM) and is based on a working link Central Bank staff. from policy interest rates to interbank interest rates and to long-term interest rates. Under our enhanced monetary policy framework, we expect to predominantly employ market-based instruments, particularly policy interest rates and open market operations (OMO) to guide the average weighted call money rate (AWCMR), which is considered as the operating target, along the desired path. This would ensure effective transmission of monetary policy. With a view to strengthening its policy formulation and modelling capacity, the Central Bank of Sri Lanka has been obtaining technical assistance from the IMF in the area of macroeconomic forecasting, modelling and policy analysis. As such, a joint effort has been made by the Central Bank and the IMF in developing a structural model-based Forecasting and Policy Analysis System (FPAS) to strengthen the monetary policy decision making process and to support Sri Lanka’s transition to a Within this enhanced framework, the flexible inflation targeting regime. The Central Bank does not set any monetary FPAS is a medium-term, pre-emptive targets explicitly. However, broad policy analysis system, which brings money (M2b) will remain as the key together information and judgment in a indicative intermediate variable, which coherent and logical manner. reflects the broad liquidity conditions in the economy, to guide the conduct of monetary policy of the Central Bank. Under the FPAS, the Central Bank has already finalised the development of the baseline version of a semi-structural To implement the new framework, Quarterly Projection Model (QPM) for macroeconomic projections, including forecasting and analysing monetary inflation projections, are currently being policy. strengthened using short-term as well as medium-term structural forecasting tools and techniques. In this endeavour, continued efforts are being made to Central Bank of Sri Lanka – ROAD MAP 2017 Meanwhile, the Central Bank is in the process of implementing several organisational changes necessary for the effective implementation of the model. Moreover, we also intend to reintroduce To this end, a separate Modelling and the Monetary Policy Consultative Forecasting Division has been setup in Committee (MPCC) in 2017, comprising the Economic Research Department and eminent academics, professionals as relevant processes are being developed well as representatives from the private while equipping the staff with adequate sector. We expect to benefit from the training. views and inputs of the MPCC in better More importantly, we intend to introduce several changes in the calibrating the monetary policy decision making process. monetary policy formulation process as In addition, we also intend to establish well. Accordingly, we will reduce the two other important consultative number of Monetary Policy Committee committees in relation to financial (MPC) meetings to 8 meetings per year system stability and private sector views from the current level of 12 meetings per on Central Bank policies and regulations. year. Consequently, around 5-6 weeks We are of the view that the inputs of will be devoted for analysing the latest such committees would also be helpful developments in the economy and in devising appropriate monetary policy developing model-based decisions. macroeconomic forecasts, thereby facilitating the provision of in-depth and more forward looking insights to the monetary policy formulation process. We will continue to monitor developments in the monetary sector closely and adopt timely and effective monetary policy measures, supported The above improvements envisaged in by other macroprudential measures in the monetary policy decision making order to ensure stable monetary process are expected to be conditions and price stability, thus implemented before the end of 2017. facilitating envisaged economic growth. This will entail revising the Monetary Law Act to accommodate some of the new changes to be introduced in this process in the medium-term. Central Bank of Sri Lanka – ROAD MAP 2017 At the same time, we will continue to actively engage in liquidity management operations in the money market to guide the short-term interest rates within the economic analyses for the purpose of desired path. formulating effective policies, while In order to ensure the effective implementation of monetary policy, we improving the transparency of monetary policy and policy communication. expect to introduce certain measures At the same time, in the process of with regard to OMOs, such as making more informed policy decisions, introducing fixed rate and variable rate we look forward to enhancing statistical auctions, and fine tuning auctions after inputs by introducing new indices on examining their need and feasibility in property prices as well as modifying line with other country experiences and wage indices, while improving the market needs. We will evaluate coverage of existing surveys to better alternative instruments to strengthen track developments in the private OMOs. sector. Reflecting these measures, inflation is The Central Bank will continue to expected to remain at mid-single digit communicate policy decisions among levels in the medium-term. As such, it is market participants and the general expected that the low inflation public through multiple means providing environment that prevailed for several greater clarity and understanding about years would be sustained in a range of 4 policy. Moreover, launching of the – 6 per cent in the medium-term, which revamped corporate website of the is also consistent with the inflation Central Bank is expected to provide high target bands stipulated under the EFF quality content with dynamic and arrangement with the IMF. interactive features. We would also continue to strengthen At the same time, continuing the the technical capability, particularly with practice that has been followed in the regard to the compilation past, we intend to make monetary policy methodologies of macroeconomic announcements according to an statistics in line with international advance announcement calendar. The standards. This will promote sound calendar for 2017 is set out below. Central Bank of Sri Lanka – ROAD MAP 2017 Monetary Policy Announcements in 2017 expending US dollars 4.0 billion of scarce external reserves in a futile attempt to 7 February, Tuesday 24 March, Friday 9 May, Tuesday 27 June, Tuesday defend the external value of the rupee through market intervention. There was a similar experience in 2015 when the currency depreciated by 6.5 per cent after spending US dollars 2.1 billion of our reserves. Wasting large amounts of 3 August, Thursday the country’s external reserves, much of 26 September, Tuesday it borrowed, in a vain effort to defend 7 November, Tuesday 28 December, Thursday the currency, which has to be ultimately depreciated anyway, is clearly unsustainable. It is time to stop this pattern and commence building up of external reserves through sustainable Volatile global market conditions and Sri foreign exchange inflows. Lanka’s vulnerability as a twin deficit country underscore the vital importance The impact of global developments, of having a flexible exchange rate policy such as Brexit, recent Presidential to adjust to external pressures. Recent elections in the United States (US) as experience has clearly demonstrated well as interest rate hikes by the US that it is unsustainable to maintain an Federal Reserve, the forthcoming overvalued exchange rate at the elections in France and Germany in expense of external reserves. A smooth Europe, the projected slowdown in the market based exchange rate would Chinese economy, as well as economic prevent highly disruptive adjustments conditions in Sri Lanka’s major trading after a period of stable rates artificially partners, including India, Japan, Russia maintained by continuous intervention and the Middle East, will also have a by the Central Bank, as experienced in significant influence on the domestic the 2011-12 period when the currency economy. depreciated by around 14 per cent after Central Bank of Sri Lanka – ROAD MAP 2017 Trends in oil prices and international notably agriculture and power capital flows, following the generation. normalisation of interest rates in the US are likely to be particularly important. As in the past, it is expected that the government would take timely measures We also expect that changes to to counter the adverse supply side government tax structure and supply effects on prices, thus mitigating shortages stemming from weather- adverse inflation expectations of the related developments as well as shocks general public. that could arise due to possible reversal of global commodity prices could cause temporary variations in price levels. In particular, if current drought conditions prevail, there could be adverse implications on price levels, while impacting on economic activities, Central Bank of Sri Lanka – ROAD MAP 2017 Accordingly, it is anticipated that inflation expectations would broadly remain anchored in the medium-term with appropriate demand management policies, supported by timely supply side measures. 4. Financial Sector Policies for 2017 and Beyond The financial system remains important from various internal and external for efficient allocation of resources and developments. hence in facilitating strong economic performance of the country. In particular, a broader, deeper and a liquid financial system is vital as economies grow more sophisticated. The Central Bank has sought to preserve the soundness, efficiency and stability of the financial system primarily through the regulation and supervision of all major categories of financial institutions, A stable financial system creates a ensuring sound and safe payment and trusted, enabling environment settlement systems as well as favourable to savers and investors; helps establishing risk management systems the transmission of monetary policy; and instilling good corporate encourages efficient financial governance standards and practices in intermediation, which eventually the financial sector while promoting promotes investment and growth; and financial inclusion. encourages effective and efficient operation of markets while improving the allocation of resources in the economy. In the medium-term, our overall aim is to ensure the stability in the financial sector through identifying emerging vulnerabilities in this sector; adopting Financial system stability is founded on early corrective actions; and the confidence of the public in the implementing a series of measures to financial system and depends on the further strengthen financial institutions, soundness and resilience of principal markets, infrastructure and safety nets. components of the financial system to collectively withstand risks emanating Our medium-term plan is to have a financial system, which offers the full range of financial products and services Central Bank of Sri Lanka – ROAD MAP 2017 to all economic sectors, including change, both nationally and agriculture, infrastructure, internationally. Considering the need for manufacturing, particularly small and upgrading of statutes in line with these medium enterprises (SMEs), and trade developments, we expect to initiate to achieve broader economic objectives amendments to the existing Banking of our country. We need to have a well- Act. Accordingly, steps will be initiated planned and an ambitious agenda for to streamline and strengthen the financial sector development and regulatory and supervisory framework reforms ranging across financial sector through the proposed Banking Act policies with a vision of innovative, amendments. We will consider robust and competitive financial provisions for reinforcing the Central systems. Banks’s enforcement powers for As a priority, we expect to strengthen the regulatory framework pertaining to all financial institutions, including licensed banks, licensed finance violations of the Act and the Directions issued under it. In this regard, we wish to seek views from the banking sector as well. companies (LFCs), specialised leasing In line with these reforms, we intend to companies (SLCs) and primary dealers. It review all key regulations in the medium- will further ensure the stability of the term. In this regard, we will review key financial sector by promoting the safety Banking Act Directions, such as share and soundness of those institutions to ownership, foreign borrowings, and face unforeseen challenges in the corporate governance, and these will be growing business environment. amended where necessary. In this regard, the Central Bank wishes to In order to maintain financial stability in implement the following policies in 2017 the country and in line with regulatory and beyond. reforms, we have identified the need for Since the last amendment to the existing Banking Act in 2006, the banking sector landscape has undergone a significant Central Bank of Sri Lanka – ROAD MAP 2017 further strengthening of the supervisory function of the Central Bank. Accordingly, we expect to enhance the bank examination methodology to focus on the efficiency, effectiveness 2014 with a view to further and sustainability of individual banks and strengthening the resilience of licensed the banking sector, based on the Bank banks. We have already issued Directions Sustainability Risk Index (BSRI). on the Basel III Liquidity Coverage Ratio Accordingly, amendments will be in April 2015. introduced to the existing risk-based supervision framework based on a mix of quantitative and qualitative indicators to enhance focus on sustainability and operational efficiency of banks. We will conduct the pilot run of the Risk Index on large banks during We have just issued the Direction on Basel III Minimum Capital Requirements for implementation on a staggered basis, commencing 01 July 2017, and to be fully implemented by 01 January 2019 in line with the international timeline. the first quarter of 2017 and With a view to creating a more resilient subsequently, the index will be extended banking sector, we expect banks to to the other segments of the banking maintain a stable funding profile. sector. Accordingly, we plan to introduce the In 2018, the Risk Index will be incorporated to all examination reports and we intend to assign a supervisory rating, based on this index. By 2019, a comprehensive pre-risk assessment will be conducted for all banks and a riskbased examination plan will be formulated. Net Stable Funding Ratio (NSFR) and the Leverage Ratio for banks. NSFR will be applicable by 01 January 2018 and the necessary Banking Act Directions on NSFR will be issued in line with the international timeline. By implementing the Leverage Ratio, it is intended to restrict the build-up of excessive leverage in the banking sector. In addition, we intend to strengthen Accordingly, in 2017, we will begin to capital positions in line with minimum monitor the level of compliance under requirements and Basel III capital the leverage ratio. standards. Implementing Basel III capital and liquidity standards were identified as key policy measures in the Road Map for Central Bank of Sri Lanka – ROAD MAP 2017 It is also our intention to finalise the Crisis Preparedness Plan, and Recovery and Resolution Framework as a framework of non-bank financial precondition for effective supervision. institutions. Accordingly, guidelines will be issued on The capital levels of licensed finance recovery and resolution frameworks of companies (LFCs) and specialised leasing banks and the crisis management companies (SLCs) are expected to be frameworks will be strengthened and strengthened further. Accordingly, streamlined in order to minimise the existing LFCs and SLCs will be required adverse impact, both on the troubled to maintain a higher minimum core banks and, on the banking and financial capital than the prevailing requirement sectors as a whole. of Rs. 400 million and Rs. 300 million, In line with the developments in the respectively. These will be increased to banking sector and the guidelines from Rs. 2 billion and Rs. 1 billion, respectively the Basel Committee on Banking on a staggered basis to facilitate the Supervision, we will be taking steps to smooth transition. This will serve as a review the existing criteria and structural capital buffer for further mechanism for the selection of the panel consolidation of this sector. It is of qualified auditors in order to expected to improve the existing strengthen the current assessment framework on capital adequacy, which process and enhancement of audit will be more risk sensitive, focusing on quality. credit risk based on borrowers’ risk In recent years, the Central Bank has introduced a broad range of prudential profiles as well as operational and market risk in the trading book. regulations to strengthen risk Further, in order to strengthen the management, corporate governance, governance framework of the non-bank capital adequacy and internal controls of financial sector, we will introduce the non-bank financial institutions. Going appropriate policy changes to the forward, the stability of the financial existing Corporate Governance sector will also be strengthened by Direction. enhancing the existing regulatory The risk management framework of non-bank financial institutions will also Central Bank of Sri Lanka – ROAD MAP 2017 be strengthened. We will amend the encourage companies to pursue organic existing Directions on classification and consolidation in order to strengthen the provisioning for non-performing loans non-bank financial sector. and advances in line with the new Accounting Standards in order to harmonise the differences between regulatory provisioning and accounting impairment. In order to mitigate undue exposures and reduce high concentration risks on investments, guidance will be given for valuation of immovable properties of LFC/SLC sector. Further, minimum liquidity In addition, more attention will be given to distressed finance companies, by resolving the difficulties largely through mergers and recapitalisation in 2017. We intend to establish an Enforcement Unit to prosecute the Board of Directors and senior management of failed finance companies who are involved in fraudulent activities and malpractices. requirement for the sector is expected With a view to strengthening the to be more stringent to create additional existing enforcement framework on liquidity buffers. prohibited schemes, the Central Bank Measures will also be taken to enhance disclosures and transparency through the introduction of a new regulatory framework for the preparation, presentation and publication of the Annual Audited Accounts/Quarterly Financial Statements and periodical returns. intends to establish a unit comprising officers with specialised skills in the areas of law, forensic and investigation skills and accounting, to liaise and assist law enforcement authorities on related investigations. This Unit will also deal with matters relating to unauthorised deposit taking institutions. In addition, the Central Bank will continue to Our objective is to reduce the overall risk enhance awareness of the general public of the financial sector by maintaining on the dangers of engaging in fewer companies but a stronger sector unauthorised investment schemes, and to avoid any contagion effect. As such, institutions authorised by the Central with the proposed changes to the Bank to accept deposits from the existing regulatory framework, we general public through an effective Central Bank of Sri Lanka – ROAD MAP 2017 public awareness campaign involving surveillance, which includes: mass media. collecting macroeconomic and financial Primary dealers play a vital role in trading of government securities and market making. Further, there is high potential to deepen the debt securities market in the country. Hence, we need to have a clearly stated policy framework for Primary Dealers. This will further enhance the safety of investments in the government securities market. Accordingly, we have already revisited the existing regulatory framework of primary dealers and based on those findings, we will introduce an appropriate regulatory framework for primary dealers in line with the latest developments in the data by customising the existing FInNet Data Reporting System of the Central Bank; (2) expanding the statistical analysis to identify system-wide vulnerabilities and threats to the financial stability from the build-up of risks and interconnectedness of financial institutions; and (3) improving the early warning framework with a focus on stress tests and financial system stability indicators, to identify and assess systemic risks and vulnerabilities in order to ensure formulation and implementation of proactive macroprudential policies to maintain financial stability. market by benchmarking the global The Central Bank has continued to take standards. We also expect to establish measures to strengthen the payment and implement a restructuring and settlement infrastructure of the mechanism for distressed primary country and to develop an efficient and dealers. stable payment and settlement system, The Macroprudential Surveillance Department (MSD) of the Central Bank capable of catering to the growing payment needs. is being strengthened to keep a close Continuing to discharge this important tab on the developments in the financial function, we expect to improve the system as a whole. In this regard, we national payment system to promote expect to strengthen the institutional electronic payments to establish a less- framework for macroprudential cash dependent society. In this regard, a payment platform is being developed to Central Bank of Sri Lanka – ROAD MAP 2017 effect government payments, applications to strengthen security of particularly the payments to Sri Lanka electronic payments. Customs, through the Common In year 2016, the Central Bank adopted Electronic Fund Transfer Switch (CEFTS) the Cabinet approved National Policy on in real time. A National Card Scheme Anti-money Laundering and Countering (NCS) is being introduced as a cost the Financing of Terrorism. Currently, all effective alternative to currently the stakeholders are in the process of available international card schemes and developing their internal frameworks to a Common Point-Of-Sale Switch (CPS) is support the national policy on Anti- being developed to facilitate clearing Money Laundering and Countering the and switching of payment cards issued Financing of Terrorism (AML/CFT). under the National Card Scheme. A Common Mobile Switch (CMobs) will be implemented to ensure interoperability between mobile wallets. Further, we will monitor the progress of licensed banks and other financial institutions joining the CEFTS, CPS and CMobs and adopt policies with a view of increasing the efficiency of electronic retail payment systems and minimising risks associated with such payment systems. Going forward, we will strengthen the supervisory framework and carryout onsite and off-site supervision of licensed service providers of payment cards and mobile payment systems to ensure compliance with regulations and guidelines. We also intend to introduce Internet Banking Guidelines and Security Standards for mobile Central Bank of Sri Lanka – ROAD MAP 2017 Sri Lanka needs to strengthen the AMF/CFT regime by effectively implementing Financial Action Task Force (FATF) recommendations in order to upgrade the country rating. If Sri Lanka fails to achieve the expected level of compliance, the country may be considered as a high risk country, resulting in adverse implications on the financial sector. In order to overcome such challenges and hence to ensure compliance, the Central Bank will focus on a number of strategic actions in the medium-term. I would also like to note that the Microfinance Act came into effect on 15 July 2016. In line with this, the Department of Supervision of Microfinance Institutions (DSMI) was established at the Central Bank of Sri management model, where the Lanka to carry out the responsibilities, as operational managers form the first line stipulated in the Microfinance Act No. of defense, and the Risk Management 06 of 2016 and implement policies and Internal Audit Departments approved by the Monetary Board to constitute the second and third lines of ensure good governance, transparency defense, respectively. and stability of Microfinance Institutions Moreover, in view of the need to build a (MFIs). governance and risk management The Central Bank is ready to receive duly framework that balances return completed applications from eligible objectives with prudent risk companies, which would be submitted management and controls, Strategic to the Monetary Board. Continuous Asset Allocation (SAA) for the surveillance and on-site examinations of international reserves, managed by Licensed Microfinance Companies Central Bank, has been developed and a (LMFCs) will be conducted by the new Investment Policy Statement has Central Bank. We expect to maintain a been drafted in line with it. The constant dialogue with the LMFCs and Investment Guidelines have been increase awareness on regulations. reviewed to reflect the revised While we are proposing policies and investment criteria. plans for the financial sector, as the apex Going forward, we expect to ensure a financial institution in the economy, we proper Enterprise Risk Management also need to ensure the stability, (ERM) Framework for the Central Bank, continuity and safety of our own house. which involves setting up a new Risk In particular, it is important to foster a Governance Structure and developing risk culture within the Central Bank as systems and procedures to monitor central banks are considered as the financial and non-financial risks of the trustee of public assets. Bank by engaging in risk mapping of all In line with this endeavour, the Central departments in order to develop a risk Bank of Sri Lanka intends to continue to profile for the Central Bank of Sri Lanka. apply the “Three Lines of Defense” risk Central Bank of Sri Lanka – ROAD MAP 2017 5. Policies to Strengthen the Broader Economy Currency Management: We want to Management of the Employees’ make sure that the Sri Lankan Rupee Provident Fund: Employees’ Provident notes and coins are available to the Fund (EPF) is the largest superannuation public in required denominations upon fund of the country having total assets demand without any shortage. We plan of Rs. 1.8 trillion. During the last year, we to develop a new mechanism for have introduced several initiatives to islandwide coin distribution and arrange enhance the overall risk management programmes with banks to collect the framework and greater oversight over coin tills issued to the public. the organisational performance of the In 2017, the Central Bank plans to issue a new coin series to reduce the cost of minting. In addition, measures are also being taken to improve the quality standards of currency notes issued by the Central Bank. Fund. In addition, the completion of Phase I of the Image Scanning Project and the automation of certain functions will improve the operational efficiency of the Fund. Going forward, we intend to strengthen the EPF operations by expanding member services to the As in the past, the currency regional level through EPF units management policy of the Central Bank established in the Central Bank Regional will be focused on maintaining quality Offices. Initiatives have also been taken standards. Accordingly, the Central Bank to re-register all members with the new plans on strict enforcement of law as biometric National Identity Card in per the Monetary Law Act on wilful consultation with the Ministry of mutilation, alteration and defacement of National Policies and Economic Affairs. currency notes in order to improve the quality of currency notes in circulation to reflect the image of the emerging Sri Lankan economy. Central Bank of Sri Lanka – ROAD MAP 2017 In line with the government policy agenda, we are in the process of reviewing investment policies by incorporating international best practices, focusing on proper assets • Enhancing the institutional capacity diversification and risk management to ensure effective and efficient with the assistance of the Asian fund management Development Bank (ADB) and the World Bank. • Improving the framework for managing financial risks Going forward, the EPF will also focus on the following; • • • Improving web based ICT the Central Bank manages public debt technologies to link employers, on behalf of the government. In employees and other stakeholders delivering this responsibility, we want to Enhancing the quality of existing make sure that our debt management database operations are conducted in a Improving the efficiency of the refund payment system • • • professional way with the highest level of integrity. Improving awareness among In this context, the Monetary Board has stakeholders on EPF operations to come up with a list of actions to develop improve the level of service delivery the debt market and debt management Establishing e-accounts for both employers and employees • Public Debt Management: As you know, operations. Some of these have already been implemented. Introducing a web based data In July 2016, we resumed Pre-bid collection and contribution payment Meetings with all the primary dealers to system facility to employers for real- provide them the relevant information in time validation of member accounts relation to the forthcoming auction. We Identification of new markets and asset classes for investments and maintaining appropriate asset hope that the availability of such market information would enhance transparency. allocations to generate the highest We are working towards publishing an level of risk adjusted return Annual Auction Calendar with more Central Bank of Sri Lanka – ROAD MAP 2017 information with the collaboration of quotes will be made mandatory. This will the Ministry of Finance, which will be enhance price guidance to the market reviewed quarterly. This will enhance the and would result in increased liquidity transparency and predictability of the due to price discovery and transparency. primary auction process in the government securities market. Such initiatives will provide the same information to all market participants thereby ensuring the availability of information on potential transactions well in advance. Further, with the intention of enhancing the transparency of our operations, since June 2016, a decision is in place not to accept more than the aggregated offered amount at an auction although the Central Bank may accept less than the amount offered. The Primary Auction Rules for government securities will also be published in order to improve transparency and the standardisation of the procedures. Meanwhile, the current auction process is being reviewed, and the draft outcome of this review has been shared with the World Bank and the IMF. The Central Bank expects to get the draft auction system validated by these international organisations before going live with it. We hope to do this in the first quarter of 2017. We have also The Bloomberg Trading Platform has invited a consultant from the US also been introduced for government Treasury to look into a number of areas, securities trading. Greater price including the auction process, cashflow discovery and transparency in the management and debt management system, as well as increased confidence, strategies, as well as establishing a good have resulted in a significant increase in database for government securities. the volume of trading on the platform, in the secondary market. The possibility of active debt management initiatives, such as buy- Further, the Bloomberg e-Trading backs, switching and swap Platform will be extended for arrangements, which are also a part of repurchase transactions, and two-way liability management initiatives, will be Central Bank of Sri Lanka – ROAD MAP 2017 explored to improve the debt diversify the foreign investor base as management process, with changes in well. We have already seen growing relevant legislation. confidence in the currency among some large international investors, which The Central Bank will establish an means that in the near future, we should Electronic Trading Platform and a be able to issue international bonds in Central Counter Party (CCP) rupees, which would minimise our arrangement for government securities exposure to exchange rate movements. along with required legal reforms to In this endeavour, we are working to deepen and broaden the secondary cooperate with the Euroclear System to market for government securities. facilitate us to trade our bonds in their Similarly, a mechanism to disseminate system in the future. Such an initiative secondary market information on debt will increase the efficiency and instruments will also be established effectiveness of settlement for investors through the proposed e-trading and increase the pool of savings platform and the clearing house. Hence, available for investment in domestic we will have a new set of operational securities. processes for government securities in the secondary market as well, in the near There will be a new Public Debt Act. A term. team of professionals is consolidating all the statutes relating to debt The Treasury is already in the process of management and a separate Debt studying the possibility of implementing Management Unit is being set up at the liability management for US dollar as Ministry of Finance. well as Rupee denominated borrowings. The Central Bank will work closely with This, in our view, is a positive the Treasury in this process. development, because for years now, the Central Bank has had to cope with We should access the international the conflict of interest of trying to capital market when market conditions conduct an independent monetary are favourable to Sri Lanka to build a policy while at the same time, raising buffer to avoid unwarranted domestic funds for the government as cheaply as market pressure due to limited resource possible. This conflict of interest poses availability. This would broaden and challenges to the monetary policy Central Bank of Sri Lanka – ROAD MAP 2017 conduct of the Central Bank. Therefore, Sri Lanka, implements a number of taking away the debt management concessionary development credit function would enable the Central Bank schemes through Participating Financial to have a greater room to manoeuvre to Institutions (PFIs), with a view to uplift conduct an independent monetary living standards to enhance financial policy. literacy as well as financial inclusion, and Foreign Exchange Management: With a view to further relaxing foreign exchange transactions, the Central Bank to ensure balanced regional growth and equitable development.  A New Loan Scheme for the Micro, has implemented several new policy Small and Medium Scale Enterprises measures in the recent past with the (MSMEs): A new loan scheme for the support of the government. We want to MSME sector development and emphasise that all our policy measures employment generation has been are in line with the current policy stance designed jointly by the Central Bank to promote the competitive advantages and the Ministry of National Policies of Sri Lanka in global business activities and Economic Affairs. It constitutes a resulting in the enhancement of investor government-led support mechanism confidence, strengthening of foreign to address financial, technical, reserves and stabilising the foreign marketing and entrepreneurship exchange market. needs, especially of youth and young The government has identified that it is timely to have a new Foreign Exchange Act. As proposed in the Budget 2017, the new Foreign Exchange bill will be presented to the Parliament during 2017. graduates, women and differently abled people. The unique feature of this Scheme is the inclusion of a special grant element for start-up enterprises to meet the initial expenses. The maximum amount of In addition, the Central bank is in the the grant will be Rs. 50,000 and the process of further relaxing foreign maximum loan amount of exchange transactions. Rs. 250,000 will be given at an interest of 5.5 per cent per annum. Regional Development: The Central The Scheme intends to allocate Bank, as the agent of the Government of Rs. 4.0 billion to the needy sectors of Central Bank of Sri Lanka – ROAD MAP 2017 the economy and is expected to implemented with the collaboration commence in January 2017. of the Ministry of National Policy and  National Strategy for Financial Inclusion: Based on the findings of the Financial Inclusiveness Survey (FIS), a comprehensive draft of National Strategy for Financial Inclusion will be developed considering the contemporary Economic Affairs, Ministry of Power and Renewable Energy, Sustainable Energy Authority and other stakeholders, with the intention of promoting rooftop solar power generation in the country.  Promoting Green Financing: In national financial inclusion strategies addition, the Central Bank will of peer countries. The views of promote Green Financing through domestic stakeholders, obtained enhancing awareness to encourage through continuous dialogue, will be enterprises to protect the considered in drafting the proposed environment, conserve resources national strategy. and to achieve carbon neutrality.  Promoting Commercial Scale Organic Agriculture and Dairy Entrepreneurship: Addressing the increased concerns of the public and Banks will also be encouraged to provide financial facilities to green enterprises with the intention of protecting the environment. the government on organic In line with the international appetite to agriculture, mainly due to the promote green financing, the Central multiple benefits that accrue from it, Bank has also joined the Sustainable the Central Bank expects to promote Banking Network (SBN) of the commercial scale organic agriculture International Finance Corporation (IFC), and dairy entrepreneurs through the which is a knowledge and capacity establishment of formal agribusiness societies and multi-stakeholder enterprises. building platform for financial regulators and banking associations of emerging markets on sustainable finance. As a  A Loan Scheme for Promoting Rooftop member of the SBN, we would focus on Solar Power Generation: A new loan sustainable banking practices to help scheme, funded by ADB, will be banks to effectively manage Central Bank of Sri Lanka – ROAD MAP 2017 environmental and social risks in the finance, with the support of IFC, we projects they finance and support intend to conduct a workshop for the businesses that are greener, climate senior staff of banking institutions in Sri friendly and socially inclusive. As an Lanka during the first quarter of 2017. important step towards sustainable Central Bank of Sri Lanka – ROAD MAP 2017 6. Concluding Remarks Ladies and Gentlemen, Some of these policies may be perceived I hope the policies and the outlook as painful in the short run, but they are unveiled in this Road Map will be a meant to strengthen medium-term catalyst in planning your activities and stability of the economy. This is crucial formulating relevant policies in the for the long-term prosperity of all Sri period ahead. At the same time, I would Lankans. like to mention that we would not be hesitant to introduce new policies and plans depending on the requirements of the economy and as contingencies arise. Such initiatives would be adopted with necessary consultation and will be clearly communicated to the stakeholders. Now, let me conclude this statement by emphasising some important points. As an agent for stability, the Central Bank would continue to play its role through clear and consistent policies to ensure overall macroeconomic stability in the country. The frameworks that are being developed are intended to support this. Our role in relation to the country’s economic performance is primarily as a facilitator. As a facilitator, we would It is clear that stability in the economy is continue to support the new growth broadly on track as evident in the model of the government, which improving macro-fundamentals. As the focuses on the central role of the private monetary authority and the apex sector. regulator of the financial system of Sri Lanka, we are making our best efforts to ensure stable economic conditions on a sustainable basis. Our policies aim at supporting the overall thrust of the government to promote investments, domestic and foreign, and enhance exports. To this end, we would be contributing through our efforts to improving the investment climate and facilitating trade, thereby Central Bank of Sri Lanka – ROAD MAP 2017 creating the conditions to harness the Priority needs to be attached to benefits of the investment-trade nexus. equitable and inclusive growth, which is In this context, I believe the initial impetus to harness the country’s considerable potential must come from the domestic private sector, particularly in the next year or two. The Megapolis Development Project as well as Master key to achieving this objective. Hence, the Central Bank will continue its role in regional development to complement these efforts. Special attention will be paid to enhancing financial literacy as a means of promoting inclusion. Plans, that have been drawn up by the I should also mention that the government for the development of government has announced its intention Hambantota, Trincomalee and Kandy, to restructure the Central Bank. We and various regional development would very much welcome a programmes will open up tremendous constructive restructuring process, investment opportunities for both which would upgrade processes and domestic and foreign investors. result in the reform of the Monetary We are also mindful that while the overall development thrust is on track, there exists disparity in the incidence of poverty across the provinces and districts, despite the progress that has so far been made in reducing overall poverty in the country. Recognising the urgent need to pay attention to this, the Law and Banking Acts, particularly to give greater powers to the Central Bank to regulate the financial system. We are confident that such moves would be instrumental in enhancing the credibility of the Central Bank, while preserving the independence it needs to perform its roles effectively. government has declared 2017 as the Before concluding, let me express my “Year of Alleviating Poverty” to sincere gratitude to a number of people eradicate poverty in all its forms from Sri who are instrumental in supporting our Lanka in line with the Sustainable efforts to achieve economic and price Development Goals (SDGs). stability and financial system stability as well as to deliver our agency and ancillary functions. I am grateful, to His Central Bank of Sri Lanka – ROAD MAP 2017 Excellency the President Maithripala excellent and highly professional advice. Sirisena, and Honourable Prime Minister Last but not least, let me commend and Ranil Wickremesinghe for their congratulate the Assistant Governors, leadership and guidance, and Heads of Departments, particularly the Honourable Finance Minister Ravi Director of Economic Research and the Karunanayake for his support, as close Staff of the Economic Research coordination between the Ministry of Department for today’s effort in Finance and the Central Bank is essential formulating the policy document, as well for sound economic management. as all Staff of the Central Bank who are I am privileged to have unstinted support and prudent inputs from the Members of the Monetary Board. Therefore, my deep gratitude is due to Secretary to the Treasury, Dr. R H S Samaratunga, Mrs. Manohari Ramanathan, Mr. Chrisantha Perera and Mr. Nihal Fonseka. They have been giving up an enormous amount of their time to address the challenging issues of the day. I am also thankful to Deputy committed to fulfilling the key objectives of the Central Bank with utmost diligence, proficiency and professionalism. On my first day in office, I said that professionalism, technical excellence and integrity are crucial guiding principles for any institution and its staff. I am very pleased to say I have seen plenty of these characteristics among the staff of the Central Bank of Sri Lanka. Governors Dr. Nandalal Weerasinghe, Thank you and I wish you all a Happy and Mr. P. Samarasiri and Mr. S. Lankathilake Prosperous New Year 2017. for their continuous support and Central Bank of Sri Lanka – ROAD MAP 2017