UPDATE 1-S.Lanka central bank defends policy after IMF report

(Adds reserve money growth details)

COLOMBO, April 1 (Reuters) - A senior central bank official in Sri Lanka defended the authority’s policies on Tuesday, arguing that the International Monetary Fund had given a misleading picture of the country’s inflation.

In a report at the weekend, the IMF said loose fiscal and monetary policies were contributing to Sri Lanka’s inflation and rising prices could not be entirely blamed on external factors such as the rising import costs of food and oil.

But Nandalal Weerasinghe, director of the economic research department at the central bank, said the IMF paper had used outdated figures and was misleading.

“We don’t agree with this. They have not incorporated our comments,” he said.

Weerasinghe pointed to core inflation of less than 10 percent to show that policies were working. This core measures of inflation strips out energy and food prices.

“We have maintained very tight monetary policy with high policy rates. The credit demand from the private sector has declined to around 15 percent in early this year from 24-26 percent in the second half last year,” he said.

Sri Lanka reported on Monday that consumer prices in March were almost a quarter higher than a year earlier, the strongest annual rise in five years.

The central bank has held its key policy rates steady for more than a year. The overnight repurchase rate is at 10.5 percent and the reverse repurchase rate is at 12 percent.

However, financial analysts also argue that central bank rates are too low. They point to a three-month bill rate of around 18.5 percent which banks prefer to use over central bank rates as the base for lending.

The central bank on Tuesday said it has managed the reserve money will within the target for the first quarter of 2008 by allowing market interest rates to rise aiming to curtail excessive demand for money.

“This has led to a substantial decline in the demand for money, helping to maintain reserve money well below the targeted level during the first quarter of 2008,” the central bank said in a statement.

The quarterly average of daily reserve money during the first quarter had remained at Rs. 273.7 billion compared with the targeted ceiling of Rs. 281.5 billion, the bank said.

The central bank governor Ajith Nivard Cabraal said on March 5, that the central bank was closely monitoringthe reserve targets for policy rates to curb inflation.

The IMF said in its report on Saturday that domestic factors were helping feed Sri Lanka’s record inflation.

“Increases in oil prices in the recent past, a common shock to most economies in the region, cannot explain most of the increase in inflation in Sri Lanka,” the IMF said.

“External shocks appear to explain about 25 percent of the variation in consumer prices and about 32 percent of the variation in core inflation.”

The central bank also defended its policies late on Monday, saying they had been successful in containing underlying inflation.

Central bank data showed that core inflation has been between 6.7 percent and 9.3 percent since January 2007.

The central bank in January said it wanted to contain the annual rise in consumer prices between 10 percent and 11 percent by the end of 2008 and bring it down to 5 percent in the medium term. It didn’t define medium term.

However, the central bank on Feb. 1 said such inflation would be between 16 percent and 20 percent up to June given the removal of a fuel subsidy and high global commodity prices. (Editing by David Christian-Edwards)