Sri Lankan Interest rates unchanged, Central Bank announces

The Central Bank of Sri Lanka has left the policy interest rates (which generally serve as a guide for interest rate changes across all banks) unchanged after a meeting on Wednesday of its Monetary Board.

In a statement, the bank said its Monetary Board, 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 14.50 per cent and 15.50 per cent, respectively, after considering the recent and expected developments in the domestic and global economy and macroeconomic projections.

The Board noted that the maintenance of tight monetary policy stance is necessary to contain any demand driven inflationary pressures in the economy, while helping to further strengthen disinflation expectations, thus enabling to steer headline inflation towards the targeted level of 4-6 per cent over the medium term.

The statement said:

Headline inflation marked a turnaround as expected

Supported by favourable supply side developments and tight monetary policy measures, headline inflation pivoted towards the envisaged disinflation path in October 2022, after passing the peak in September 2022. Accordingly, headline inflation, based on both the Colombo Consumer Price Index (CCPI) and the National Consumer Price Index (NCPI), decelerated, while a deceleration was observed in core inflation. The deceleration in inflation is expected to continue in the ensuing period, supported by subdued aggregate demand pressures, expected improvements in domestic supply conditions, normalisation in global commodity prices, and the timely pass-through of such reductions to domestic prices, along with the favourable statistical base effect. Global as well as domestic risks to the inflation outlook in the near term are tilted to the downside, thereby supporting the disinflation path and stabilising inflation at the desired levels towards the end of 2023.

Domestic economic activity is expected to remain tepid during 2022

The real economy is expected to contract in 2022 impacted by the stability-oriented policy measures that led to tightened monetary and fiscal conditions, along with supply side constraints and prevailing uncertainties, among others. Nevertheless, economic activity is expected to make a gradual, yet sustainable recovery, supported by envisaged improvements in supply conditions, improved market confidence, and the impact of corrective policy measures being implemented to stabilise the economic conditions.

Tight monetary and liquidity conditions have slowed the expansion of money and credit aggregates

Outstanding credit extended to the private sector by commercial banks is expected to have contracted for the fifth consecutive month in October 2022, reflecting the impact of increased market lending interest rates and the moderation in economic activity. Market deposit interest rates have also risen notably disproportionate to the adjustment in the policy interest rates. The continued excessive upward adjustment in market interest rates, despite the improvements in domestic money market liquidity and the deceleration of inflation, has resulted in persistent

The external sector remains resilient despite the heightened balance of payments pressures

The merchandise trade deficit for the ten months ending October 2022 contracted significantly, owing to the robust export earnings and a substantial decline in import expenditure due to policy measures taken to curtail demand for imports, amidst the shortage in foreign exchange. Workers’ remittances are expected to improve in the period ahead with rising departures for foreign employment, while the tourism sector is set to mark an improvement in view of the upcoming season for tourist arrivals. Amidst the improvements observed in liquidity in the domestic foreign exchange market, the Central Bank continued to facilitate the import of essential goods to ensure the availability of energy, power and other supplies necessary for uninterrupted economic activity. Meanwhile, the exchange rate remained broadly stable. The gross official reserves were estimated at US dollars 1.7 billion as of end October 2022, including the swap facility from the People’s Bank of China, equivalent to around US dollars 1.4 billion, which has certain conditionalities on usability. Risks to external demand could emerge amidst moderating global growth prospects in the near term, however, rising prospects of the tourism sector and workers’ remittances would help offset any negative spillovers to a large extent.

The Central Bank would expect a moderation of excessive market interest rates, in line with the prevailing policy interest rates. If an appropriate downward adjustment in the market interest rates would not take place in line with the envisaged disinflation path, the Central Bank will be compelled to impose administrative measures to prevent any undue movements in market interest rates. At the same time, the Board reiterates its continued commitment to restoring price stability and ensuring financial system stability, and remains confident that inflation would follow the projected disinflation path underpinned by the prevailing monetary policy stance, while supporting the economy to reach its potential over the medium term.