Although the Finance Minister earlier vowed not to 'print' money, the authorities have done so by injecting massive amounts of liquidity through the purchase of Treasury Bills at artificially low rates.
By November 10, 2004, the Central Bank holdings of T-Bills had risen to more than Rs.69.5 billion up from just Rs. 10 billion in January.
A part of this was to compensate for the rupees going out of the system, due to falling reserves.
"The acceleration in the monetary aggregates so far in the year indicates the possibility of the onset of demand-fuelled pressure on inflation," Central Bank warned in last Wednesday's Monetary Policy statement.
"The Central Bank is of the view that a tightening of Monetary Policy is therefore, required to curb the build up of inflationary pressure and inflationary expectations in the economy."
Central Bank raised policy rates by 0.5 per cent this week, to curb excessive money growth.
Central Bank said its target money supply was growing at 18 percent, much higher than the revised mid year target of 15 percent.
Minister Amunugama says the government printed money as the final resort.
"Money is printed when the budget gap is large. When all your revenue streams are exhausted you create money to meet the part of the gap. If you don’t want to print money as we plan to do that will be a way of squeezing," he told LBR.
He said he is hoping that the budget would stimulate economic activity next year to match the rising money supply.
"We have to have more goods and services which will mop up extra money in circulation," he said.
By the time Central Bank started tightening policy, this week, inflation has already overtaken interest rates by a wide margin.
The EPF and ETF were also forced to by billions of rupees worth of Treasury Bills at artificially low rates resulting in unprecedented losses to the beneficiaries of the funds.
Savers also effectively subsidized the corporate sector which was able to get cheap loans from banks at negative real rates.
The purchase and the sale of treasury securities is a key instrument of controlling money supply in a country. When the Central Bank buys Treasury Bills it releases liquidity into the circulation of money in the country.
When it sells Treasury Bills, money is taken out of the system.
But when this is done for purely Monetary Policy purposes, which is to control the money supply and control inflation, Central Bank does not 'monetize’ the debt.
Critics say the recent purchase of Treasury Bills by the Central Bank, especially at negative real rates in clear evidence of 'debt monetization' on a grand scale, which went counter to the stated Monetary Policy objectives of the bank.
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The Central Bank Monetary Board’s bold decision last Wednesday to raise interest rates by fifty basis points surprised the money markets.
Many analysts had then predicted that the board would pass this year without an upward revision of the benchmark rate.
By Friday the call market picked up about half a per cent.
But even now Prime Lending Rate (PLR) still remains well below the official inflation figure of 12.1 for October as shown by the Colombo Consumers Price Index, giving massive subsidies to the corporate sector.
-LBR Newsdesk: LBOEmail@vanguardlanka.com