CORRECTED -Policy interest rates rise in SL’s Central Bank monthly review

The Monetary Board of the Central Bank (CB) raised interest rates in its latest monthly policy review announced on Thursday, in addition to introducing several measures to improve from the current dollar shortage.

The Monetary Board decided to increase the Standing Deposit Facility Rate (SDFR) and the Standing Lending Facility Rate (SLFR) of the Central Bank by 50 basis points each, to 5.50 per cent and 6.50 per cent, respectively, the CB said in a media release.

The Monetary Board said it decided to distribute the financing of essential import bills for fuel purchases among the licensed banks in proportion to their foreign exchange inflows; mandate all registered tourist establishments to accept foreign exchange only in respect of services rendered to persons resident outside Sri Lanka; extend the payment of an additional Rs. 8 per US dollar for workers’ remittances paid in addition to the incentive of Rs. 2 per US dollar offered under the “Incentive Scheme on Inward Workers’ Remittances” until 30 April 2022, reimburse the transaction cost borne by Sri Lankan migrant workers through the payment of Rs. 1,000 per transaction, when remitting money to rupee accounts via licensed banks and other formal channels with effect from 01 February 2022 and introduce higher interest rates for both foreign currency and rupee denominated deposits of migrant workers.

The CB said the economy is expected to have recorded a growth of around 4 per cent in 2021.

As per the data released by the Department of Census and Statistics, domestic economic activity that was disrupted with the outbreak of the third wave of the COVID-19 pandemic and related mitigative measures is estimated to have contracted by 1.5 per cent, year-on-year, during the third quarter of 2021.

However, economic activity towards the latter part of 2021 appears to have gathered momentum as several leading indicators point towards activity returning to normalcy along with the successful vaccination drive of the Government.

With the normalisation of global economic activity, a notable improvement in export performance was observed, with monthly exports remaining in excess of US$1 billion, consecutively since June 2021. Meanwhile, expenditure on imports increased significantly, partly reflecting the increased international prices, the demand for intermediate goods, and a more than expected demand for consumer goods.

The statement said the increase in imports was also underpinned by the availability of low cost credit, which led the trade deficit to widen to pre-pandemic levels in 2021. Meanwhile, developments in the tourism sector appear to be promising with the influx of tourists in recent months.

Although inflows in the form of workers’ remittances have reduced somewhat in the latter half of 2021, the introduction of special incentive schemes and the actions taken by the authorities to curb illegal fund transfers have generated renewed interest in routing funds through formal channels. As of end 2021, the gross official reserves were estimated at $3.1 billion.

Credit extended to the private sector, which slowed down during September and October 2021, has picked up recently, partly reflecting the increased credit flows to finance imports. In the meantime, credit obtained by the public sector from the banking system, particularly net credit to the Government, continued to expand.

Inflationary pressures in the domestic front continued to be fuelled by supply side disruptions, upward adjustments to administered domestic prices, and the strengthening of underlying demand conditions in the economy as reflected in the rise in core inflation. Such supply driven price pressures are expected to be transitory, although the possible build-up of demand driven inflationary pressures may compel the adoption of proactive monetary policy measures, which will also help in managing inflation expectations.

The Monetary Board was of the view that the new measures will curtail the possible build-up of underlying demand pressures in the economy, which would also help ease pressures in the external sector, thus promoting greater macroeconomic stability.

In keeping with this policy stance, the Central Bank expects a corresponding increase in interest rates, particularly in deposit rates, thereby encouraging savings, while discouraging excessive consumption, which also fuels imports. Therefore, financial institutions are urged to swiftly pass on this increase to deposit rates of the customers, the statement said.