Sri Lanka cuts rates to boost growth, signals pause in further easing

COLOMBO: Sri Lanka’s central bank lowered interest rates on Friday in an unexpected move to boost growth but signalled a pause in easing for the time being, while projecting inflation would remain subdued over the medium term.

Helped by a International Monetary Fund bailout, the South Asian island nation is recovering from its worst financial crisis in seven decades and awaiting the finalisation of its first review from the global lender.

The Central Bank of Sri Lanka (CBSL) lowered key rates by 100 basis points (bps), reducing the standing deposit facility rate and the standing lending facility rate to 9% and 10%, respectively, and taking total rate cuts to 650 bps since the current easing cycle began in June.

CBSL had raised rates by a record 10.50 percentage points to bring down sky-high inflation between April 2022 and March this year.

The board arrived at the decision, “with the aim of achieving and maintaining inflation at the targeted level of 5% over the medium term, while enabling the economy to reach and stabilise at the potential level,” it said in a statement.

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With this reduction, further easing will be paused in the near term, it added, given that space exists for market interest rates to adjust downwards and reiterated the need for that to happen to ease domestic monetary conditions further.

“This rate cut is independent of an IMF decision on the first review. Growth is below expectation. So to stimulate growth they are front-loading the policy rate cut,” said Udeeshan Jonas, chief strategist at equity research firm CAL.

The CBSL has forecast Sri Lanka’s economy will shrink 2% this year after a 7.8% contraction in 2022 when it went into a tailspin because of a severe foreign exchange shortage. The World Bank, however, has predicted a 3.8% contraction in 2023.

Benefiting from a more stable economy, the Sri Lanka rupee has appreciated by 10.7% against the U.S. dollar so far this year.

Thilina Panduwawala, head of research at Frontier Research said the central bank’s guidance, putting a hold on further easing for the time being appeared to be influenced by expectations that the inflation trajectory will rise more sharply than previously thought in 2024.

The slower transmission of rate cuts to borrowers and the broader economy since October was another reason for flagging the pause in easing, he said.

CBSL said there are upside risks to inflation projections in the near-term due to supply-side factors but said such risks would not materially change the medium term inflation outlook as public inflation expectations remain anchored and economic activity will remain below par in the near to medium term.