Sri Lanka resumes rate cuts to boost growth as inflation ebbs

Sri Lanka’s central bank resumed interest rate cuts on Thursday to boost growth as the government seeks to lift revenue and repair its balance sheets in a bid to sustain financial support from the International Monetary Fund.

The Central Bank of Sri Lanka (CBSL) lowered the standing deposit facility rate and the standing lending facility rate by 100 basis points each to 10% and 11%, respectively, it said in a statement. The cuts followed a decision at the last policy meeting in August to keep rates unchanged.

“The Board arrived at this decision following a careful analysis of the current and expected developments,” the bank said in the statement.

The rate cut was in line with market expectations and comes amid cooling inflation in the South Asian country.

Sri Lanka’s economy was crushed last year under its worst financial crisis in more than seven decades, with inflation sky-rocketing and foreign exchange reserves falling to record lows, severely stunting its ability to import essential commodities.

The central bank responded by increasing rates a total of 10.5 percentage points to contain inflation and rebuild reserves to shore up its currency. Since June, however, the CBSL has now reduced rates by a total 550 bps as the economy stabilised following a $2.9 billion rescue package from the IMF in March.

Following the rate cuts, the prices of international bonds issued by the country rose, with May 2027 maturity bond leading the gains.

IMF REVIEW FINALISATION KEY

Sri Lanka failed to reach an agreement with the IMF in its first review of the bailout package last month, due to a potential shortfall in government revenue.

That could delay the release of the second tranche of $330 million worth funds under the bailout.

The central bank’s governor, P. Nandalal Weerasinghe, said the country was trying to get the first review completed by the end of October and approval by the IMF Board in November.

“Growth is not enough and the only way to stimulate growth is with monetary policy. Even with policy loosening Sri Lanka could find it difficult to post (a 2% contraction) this year,” said Udeeshan Jonas, chief strategist at equity research firm CAL Group.

Stronger growth would also encourage imports, boosting tax revenues.

Imports shrank about 14% to $11 billion in the first eight months of this year compared with 2022.

“CBSL is supporting lending rates downwards and hoping they fall to levels that borrowers are comfortable to increase borrowings significantly,” said Thilina Panduwawala, head of research at Frontier Research.

Weerasinghe also said the current benign price outlook in the domestic economy would help stabilise inflation at 5% in the medium-term, as mandated under a new Central Bank Act, and enable the economy to reach its potential growth.

However, a recent uptick in global oil prices and the impact of probable tax measures that will be announced in the federal budget in November could temporarily push up prices, he added.

In the last six months, Sri Lanka has seen inflation drop to just 1.3% in September, its currency appreciate by about 12% and foreign exchange reserves improve.

The World Bank this week revised up its economic forecasts for the country and now expects its economy to shrink 3.8% in 2023 versus 4.2% earlier. The CBSL sees a 2% contraction.

The central bank reiterated that it would like to see market interest rates come down further and its chief said he was hoping to see progress on the debt restructuring talks in the near future.

The CBSL “will continue to closely monitor the developments in market lending interest rates and review the administrative measures appropriately”, it said in a statement.

(Reuters)