Central Bank on retaining of policy interest rates at current levels

The Monetary Board of the Central Bank of Sri Lanka, at its meeting held on 1 October, decided to maintain policy interest rates at their current levels. 

Accordingly, the Standing Deposit Facility Rate (SDFR) and the Standing Lending Facility Rate (SLFR) of the Central Bank will remain at 7.25% and 8.50%, respectively.

The Board arrived at the above decision after carefully considering current and expected developments in the domestic and global economy, with the aim of stabilising inflation at mid-single-digit levels in the medium term to support growth. Tight monetary policy conditions are observed globally with a continuous strengthening of the US dollar

The broad-based strengthening of the US dollar subsequent to the increase in policy interest rates by the Federal Reserve and expectations of further interest rate hikes have exerted pressure on emerging market economies (EMEs). In response, EMEs with significant pressure on local currencies have tightened their monetary policy stance by raising policy interest rates. Meanwhile, the recent upward trend observed in international oil prices is likely to exacerbate challenges faced by the global economy.

External sector recorded a mixed performance and the exchange rate depreciated at a faster pace

The deficit in the trade account continued to expand during the first seven months as import growth outpaced export growth. The substantial surge in import expenditure was driven by the growth in imports of fuel, gold and personal motor vehicles. 

Even though services related inflows such as tourism performed notably and the financial account of the Balance of Payments (BOP) strengthened during the year, outflows of foreign investment from the government securities market exerted pressure on the BOP. 

High import growth and capital outflows, in the context of a strengthening US dollar, exerted significant pressure on the exchange rate. Accordingly, in line with several other peer countries such as India, the Philippines and Indonesia, the Sri Lankan rupee depreciated at a faster pace of 9.7% against the US dollar during the year up to 1 October 2018. 

In addition to the Central Bank intervention to curtail disorderly adjustment in the exchange rate during the first few weeks of September 2018, both the Central Bank and the Government introduced a raft of policy measures including margin deposit requirements for letters of credit opened for the importation of personal motor vehicles, cash margins on selected non-essential consumer goods imports and the suspension of concessionary vehicle permits for a limited period. These measures are expected to ease the excessive demand for foreign currency and hence the pressure in the domestic foreign exchange market as already observed in the stabilising exchange rate.

Moderate growth in the domestic economy is expected to pick up

According to the provisional estimates of the Department of Census and Statistics (DCS), the Sri Lankan economy grew by 3.7% in the second quarter of 2018, while estimates for the first quarter of 2018 were revised upward from 3.2% to 3.5%. 

Economic growth in the second quarter of 2018 was propelled by the positive momentum in the Services and Agriculture sectors, while Industry sector growth remained moderate. Based on current economic developments and projects, it is expected that the economy will expand during the remaining quarters of the year at a rate higher than the first half of 2018. 

The competitive flexible exchange rate, low inflation environment and structural reforms that are currently being undertaken by the authorities to support exports and investment are expected to facilitate stronger and sustained growth over the medium term.

Inflation to remain within 4-6% target range despite recent transitory price pressures

Following the transitory uptick in inflation in the previous months due to the impact of upward adjustments to administered prices and higher volatile food prices, headline inflation decelerated in September 2018 primarily due to lower food prices. 

However, further upward price revisions to domestic petroleum products and other administered prices as well as imported inflation arising from the impact of currency depreciation could exert some pressure on inflation in the coming months. 

Nevertheless, despite these transitory pressures, inflation is likely to tape further on the back of decelerating food prices and favourable base effect during the remaining period of the year. With appropriate policy adjustments, inflation is expected to remain within the 4-6% target range over the medium term. 

Short-term market interest rates have responded to domestic market conditions, while monetary expansion continued its gradual deceleration

In response to the prevailing tight liquidity condition in the domestic money market, short-term interest rates have adjusted upwards, while an uptick is observed in the yields on government securities in both primary and secondary markets. 

Moreover, market interest rates, particularly lending interest rates in many market segments, continue to remain at elevated levels. Hence, Sri Lanka’s real interest rates still remain well above several peer EMEs, reflecting already tightening bias in monetary policy.

Credit extended to the private sector continued to decelerate, buttressing the moderation of broad money growth in August 2018. These trends in monetary and credit expansion indicate greater monetary stability, which is consistent with the envisaged medium-term growth path of the economy. Moreover, based on the data up to the first half of 2018, credit to all major sectors of the economy has expanded, indicating the availability of adequate financial resources to support economic activity.

Policy interest 

rates unchanged

Based on current and expected macroeconomic developments and taking into consideration the measures taken to address the prevailing imbalances, particularly in the external sector, the Monetary Board of the Central Bank was of the view that the continuation of the current monetary policy stance was appropriate. Accordingly, the Monetary Board decided to maintain the Standing Deposit Facility Rate (SDFR) and Standing Lending Facility Rate (SLFR) of the Central Bank at their current levels.