ranee jayamaha : recent economic developments, challenges and strategies – proactive strategies in reducing inflation speech by dr ranee jayamaha, deputy governor of the central bank of sri lanka, at the central bank of sri lanka, colombo, 25 may 2007. * * * inflation is a common enemy. its impact will be felt by every single person in a country. managing inflation and reducing inflationary expectations cannot be achieved by the central bank of sri lanka ( cbsl ) alone. it can only be done collectively and with cooperation from all stakeholders. who are these critical stakeholders? cbsl, the government, banks and financial institutions, fund managers / traders / dealers operating in various markets, investors both local and foreign households and consumers. 1. central bank of sri lanka given its prime objective of maintaining price stability, cbsl has been proactive in the conduct of monetary policy, which is the instrument through which this purpose can be achieved. cbsl sets monetary targets taking into consideration growth prospects of the economy, liquidity requirements necessary to facilitate growth and inflation at a desired level. the ultimate aim is to keep inflation at desirable levels and reduce inflationary expectations. cbsl, at its disposal, has a limited number of instruments to conduct monetary policy. the current framework places greater reliance on market - based instruments, such as changes to the policy interest rate and conduct of open market operations. accordingly, cbsl has announced its monetary policy strategy and targets at the beginning of 2007. the upfront announcement of the policy targets indicates the transparency of monetary policy operations and we believe that it helps to enhance policy effectiveness. more importantly, it helps the other stakeholders to fall in line with the announced strategy. 2. government the fiscal policy should support monetary policy to work effectively. therefore, government ’ s commitment to maintain fiscal targets is essential. according to the government ’ s medium term macro framework enunciated in the fiscal management report 2007, the overall deficit in 2007 will be contained at around 7. 2 % of gdp. the govt. has taken significant steps to enhance revenue through additional measures such as improvement to tax administration, rationalize current expenditure and improve its debt management policy. the achievement of the first quarter 2007 revenue target is commendable. while maintaining the momentum in revenue targets, it is also necessary to reduce govt. expenditure and work in tandem with monetary policy to contain inflation. in reducing government expenditure, it is also desirable to link income policies of the govt., in particular, wage increases

##ful of the uncertainties they create in the forex market which is not conducive to its smooth operations and, therefore, the perception by international markets and investors. as you are aware, worker remittance has financed around 69 % of sri lanka ’ s trade deficit. there has been an increase in worker remittances in the recent past responding to active promotional campaign launched by cbsl with the support of the sri lanka foreign employment bureau, overseas job agencies, foreign missions and the banks. recently, the number of professionals and skilled worker categories were encouraged to take up foreign employment, which is catching up fast. banks should make extra efforts to mobilize their remittances, as this will add to their fee - based income through enhanced financial services. the increase in remittances will have a beneficial impact in reducing the current account deficit and creating a greater stability in the foreign exchange market. govt. securities market commercial banks and a few non - banks are the primary dealers who buy and sell govt. securities and create secondary transactions in this market. the govt., tends to borrow from the debt securities market which is non inflationary. it appears that there are market collusion and cartel type operations which tend to drive returns on treasury bills and bonds to levels which are not in line with the current and expected movements in key macro variables. often, cbsl has to reject bids because of the very high bidding rates quoted by primary dealers. cbsl is the banker to the govt. when market collusion does not enable the govt., to borrow at reasonable rates, cbsl has to take treasury bills which inflating financing, as it compels cbsl to issue reserve money into the system which has multiple effects in increasing money supply and liquidity in the system. primary dealers, specially the banks, have a responsible role to play in this regard and be mindful of unusually high bidding and its repercussions on the whole economy. 5. investors and the business sector one way of beating inflation is to enhance productivity. improvements to the factor productivity should be introduced using improved technology and higher productivity methods. investing in technology today will not only increase productivity but also help lowering product prices. they may have to look for foreign collaboration, joint ventures and partnerships if additional funding and technical skills are not available within the country. they should also facilitate investments outside the western province and promote regional development and employment generation in outstations while using factors of production available in such