* Sri Lanka non-borrowed forex reserves have declined -IMF
* IMF: Cbank fx sales not in line with current economic fundamentals
* Sri Lanka's 2011 economic growth to be around 7.5 pct
* Cenbank says sold dollars to maintain rupee stability
Shihar Aneez
Sri Lanka's central bank should limit its intervention in the foreign exchange market and allow flexibility in the rupee LKR= exchange rate, the International Monetary Fund said on Wednesday.
Sri Lanka agreed to a $2.6 billion IMF loan programme in July 2009 after its foreign exchange reserves hit an eight-year low of $1.3 billion, while foreign investors withdrew money in government securities during the global financial crisis.
The latest central bank data show the country's reserves hit a record $8.1 billion at the end of July, equivalent to 5.8 months' worth of imports.
"While headline reserves are at a comfortable level.. non-borrowed reserves..have steadily declined, reflecting foreign exchange sales by the central bank," Brian Aitken, the IMF mission head told reporters in Colombo after concluding discussions on the seventh review of the loan programme.
"This policy does not seem to be in line with the current fundamentals of the economy," he said. "In responding to market pressures, the central bank should...limit its intervention and allow more exchange rate flexibility."
The global lender has repeatedly asked the central bank to allow flexibility in the exchange rate, but the central bank has said strong inflows from remittances and post-war investments have resulted in upward pressure on the currency.
INTERVENED FOR STABILITY
"In July and August we had to intervene due to heavy oil bills coming into the market and sell some amount (of dollars) to maintain the stability in the market," K.D. Ranasinghe, the central bank's chief economist, told Reuters.
"The net internal reserve, which excludes short term borrowing, is above $6 billion. There are no immediate risks or concern over reserves. We expect more foreign inflows and more remittances in the next few months."
Since the rupee hit a record low in April 2009 it has appreciated just over 10 percent thanks to the IMF programme and the government's fiscal and financial policies after ending a 25-year war in May 2009.
"We are trying to set the situation based on our projections on external developments, which we acknowledge are uncertain," Aitken told Reuters.
"Given our projections at this moment we would like the central bank... to avail themselves to more exchange rate flexibility, to allow the market forces to reflect."
In 2008, the central bank artificially boosted the rupee by selling some of its reserves but then was forced to give it more flexibility in October that year, resulting in around a 6 percent fall in the currency up to April 2009.
"Flexibility in the exchange rate, which has appreciated substantially in real terms over the past two years, is also an essential component in ensuring Sri Lanka's export competitiveness," Aitken said.
The global lender expects the island's economy to grow around 7.5 percent this year, below the central bank's estimate of a record 8.5 percent.
The IMF, while satisfied with Sri Lanka's fiscal performance, said the $50 billion economy's rapidly increasing credit demand should be monitored closely.
Private sector credit growth hit a 16-year high of 34.4 percent year-on-year in June, central bank data showed.
"Sustained rapid credit growth bears close monitoring and may need to be slowed in order to prevent future inflationary pressure. Banks and other financial institutions should also guard against a relaxation of lending standards and the accompanying risk of a build-up of nonperforming loans," the IMF said. (Reporting by Shihar Aneez; Editing by Andrew Hay)
reuters
