Our motivation towards adopting inflation targeting as the monetary policy framework was signaled a number of years ago, as we recognised it as the most appropriate way to escape from the high inflation-low growth trap. The weakened relationship between money and inflation and deepening financial markets were among the major factors that encouraged this move. Under the proposed FIT framework, the Central Bank will aim to preserve price stability of the economy by targeting an inflation range of 4-6 per cent. We believe that this target range is desirable for a country like ours in view of the vulnerability of the economy to supply or external shocks. We will employ market-based instruments, particularly the policy interest rates and open market operations (OMO) of the Central Bank, to influence market conditions and to navigate inflation in the targeted mid-single digit range. Variables such as overall monetary expansion and credit disbursements to the private sector by commercial banks will remain as key indicative variables to guide monetary policy conduct. We have now progressed into a time-bound plan to make this leap towards FIT a reality. The period starting from 2018 will be vital in laying out required reforms to facilitate a smooth transition to a FIT framework. In this context, we have identified three important pillars as the building blocks for adopting a FIT framework; 1. Strong Central Bank mandate and credibility 2. Effective monetary policy conduct 3. Strong fiscal policy support and commitment Now let me discuss some key elements and building blocks of FIT.
This is largely aimed at institutional features, organisational features, operational features, monetary policy implementation, exchange rate policy and foreign exchange operations as well as capacity building, while aligning both fiscal and monetary policy towards achieving economic targets set in a coherent manner. When setting our monetary policy actions and directions, we cannot disregard the external environment. In the global economy, for the first time since the Global Financial Crisis, there is currently a divergence of monetary policy among the major economies. This is likely to result in greater volatility in capital and currency markets. This requires us to be vigilant. We are aware that interest rate hikes in advance economies such as the US and the UK as well as in emerging economies could have some spillover impact on the Sri Lankan economy through capital reallocation. Meanwhile, economic and political developments in major export destinations, as well as trends in key commodity prices, will also have a significant impact on the domestic economy. 16  3. Financial Sector Policies for 2018 and Beyond Being guided by its mandate, the Central Bank promotes a dynamic and resilient financial sector, which supports sustainable growth, primarily through regulation and supervision of financial institutions, ensuring sound and safe payment and settlement systems, establishing risk management systems and instilling good corporate governance standards and practices in the financial sector.