Interest rates unchanged in latest SL monetary review

The Monetary Board of the Central Bank of Sri Lanka, at its meeting held on Wednesday, decided to maintain the Standing Deposit Facility Rate (SDFR) and the Standing Lending Facility Rate (SLFR) of the Central Bank at their current levels of 11 per cent and 12 per cent, respectively.

“The Board arrived at this decision following a careful analysis of current and expected developments in the domestic as well as the global economy, while noting the significant easing of monetary conditions effected since June 2023. The Monetary Board took note of the downward adjustment of market interest rates in response to monetary policy easing measures implemented thus far and the need to allow space for further adjustment of market interest rates swiftly. However, the Board observed that market interest rates of certain lending products remain excessive and are not in line with the current monetary policy stance. Moreover, the Board anticipates a faster reduction in overall market lending interest rates in line with the recent monetary policy easing measures. Accordingly, the Board decided to adopt targeted administrative measures to reduce specific lending interest rates that it considered to be excessive and direct the licensed banks to reduce overall rupee lending interest rates by an appropriate margin in the period ahead,” the Central Bank said in a statement on Thursday.

The statement said:

Disinflation trend continues, with headline inflation reaching single digit levels

Headline inflation, measured by the year-on-year change in the Colombo Consumer Price Index (CCPI, 2021=100), decelerated to 6.3 per cent in July 2023, reaching single digit levels for the first time since November 2021. Following a similar trend, headline inflation, based on the National Consumer Price Index (NCPI, 2021=100), also decelerated to 4.6 per cent in July 2023 (year-on-year). The moderation in headline inflation was mainly driven by the softening of energy and food inflation, along with the favourable statistical base effect. Meanwhile, CCPI and NCPI based core inflation, which reflects underlying demand pressures in the economy, moderated to 6.1 per cent and 6.3 per cent, respectively, in July 2023 (year-on-year). Headline inflation is expected to moderate further over the next few months and stabilise around mid-single digit levels over the medium term.

Domestic economic activity is expected to recover in the second half of 2023 and gradually reach the potential level of economic growth over the medium term

Economic activity is projected to recover gradually during the second half of 2023 and reach its potential level thereafter, supported by the normalisation of monetary conditions, improvements in business confidence, enhancements in supply conditions and the relaxation of import restrictions, and the impact of growth promoting structural reforms. Leading indicators of economic activity point to a lower contraction in GDP in the second quarter of 2023, compared to the previous projections, while the second half of 2023 is expected to record a positive growth, compared to the same period in 2022. However, the impact of weather related disruptions and modest external demand conditions could weigh on expected growth in the near term.

External sector remains resilient, allowing a gradual relaxation of balance of payments restrictions

The trade deficit decreased notably during the seven months ending July 2023 with a significant decrease in merchandise imports, despite the decrease in merchandise exports. Earnings from tourism and workers’ remittances, which improved considerably from January to July 2023, in comparison to the corresponding period in the previous year, are expected to improve further in the period ahead. Despite some recent outflows from the government securities market, net foreign investment inflows remained positive during the seven months ending July 2023. In view of the improvements in the balance of payments conditions and the need to support the recovery of activity, the Government relaxed import restrictions related to 638 HS codes, including those of commercial vehicles, since June 2023. Although a significant share of import restrictions has already been relaxed, demand for imports continued to remain subdued, reflecting the tight financial conditions. The Sri Lanka rupee recorded an appreciation of around 12 per cent against the US dollar thus far during the year. The level of gross official reserves was estimated at around US dollars 3.8 billion as at end July 2023, including the swap facility from the People’s Bank of China, while measures were also taken to repay a part of the swap facility with Bangladesh Bank, in addition to the repayment of maturing debt of multilateral lending agencies.

Market interest rates continue to adjust downward, although disparities in adjustments remain

Reflecting the impact of monetary policy easing measures effected since June 2023 as well as the decline in the risk premia with the announcement of the domestic debt optimisation (DDO) operation, market interest rates have declined to a certain extent. A notable reduction was also observed in the yields on government securities. However, the downward adjustment in market lending interest rates has been disproportionate to the reduction effected in market deposit interest rates. Furthermore, despite the considerable easing of monetary conditions, interest rates on certain lending products of some financial institutions continue to remain excessively high posing hardships for individuals and businesses, particularly small and medium scale enterprises. The reduction in the Statutory Reserve Ratio (SRR) from mid-August 2023 is expected to have eased liquidity strains of licensed commercial banks (LCBs) and lowered their cost of funds, facilitating a further downward adjustment in lending interest rates. Meanwhile, based on data available until July 2023, a sustained recovery in credit extended to the private sector by LCBs is yet to be observed. Therefore, it is essential that market lending interest rates are lowered by financial institutions in line with the eased monetary policy stance of the Central Bank, thereby boosting credit flows to the economy, which in turn would help the revival of economic activity.

The release of the next regular statement on monetary policy review will be on 5 October 2023.