Sri Lanka's central bank raised interest rates for the first time in eight months on Friday, saying tighter policy was a precaution against a build-up of inflationary pressures. Its fourth tightening step in 16 months comes two weeks after the International Monetary Fund (IMF) urged authorities to tighten monetary policy amid heavy capital outflows as foreign investors sold government securities this year.
Policymakers face a tricky balancing act as the outflows have put renewed pressure on the rupee, but higher borrowing costs are likely to further cool the economy. Economic growth slowed to a three-year low of 4.4 percent in 2016, from 4.8 percent the previous year. The central bank later revised down growth target for 2017 to 5-5.5 percent from 5.5-6 percent.
"We are not happy about monetary side developments and credit growth has not slowed as much as we expected," Central Bank Governor Indrajit Coomaraswamy told reporters in Colombo. The central bank raised rates by 25 basis points, pushing the standing deposit facility rate (SDFR) to a four-year peak of 7.25 percent and the standing lending facility rate (SLFR) to 8.75 percent, its highest since July 2013. The rate hike was necessary "to contain the build-up of adverse inflation expectations and the possible acceleration of demand side inflationary pressures through excessive monetary and credit expansion," the central bank said in a statement.
A Reuters poll this week showed economists were split on a possible rate increase. "There are external pressures like the US raising interest rates, bond outflows and IMF pressure to tighten monetary policy," said Yohan Samarakkody, head of research at SC Securities, while adding that the tightening pace was a bit too fast. The IMF on March 7 urged the central bank to tighten monetary policy if credit growth or inflation do not ease.
The central bank last tightened monetary policy in July.
Private sector credit growth remains stubbornly high, which has added to price pressures. Credit grew 20.9 percent year-on-year in January, compared with 21.9 percent in December. Coomaraswamy expected the pace to slow to 15 percent by year-end. Inflation in February hit a record high, pushed up by the impact of a lingering drought. The island nation's government has kept a tight leash on fiscal policy to trim the budget deficit in line with a $1.5 billion IMF loan condition. Foreign investors net sold government securities worth 63.3 billion rupees ($417.8 million) so far this year, exerting pressure on the currency. The rupee has fallen 1.4 percent so far this year after a 3.9 percent slide last year.
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