In a surprise move, the Central Bank yesterday tightened key monetary policy rates by 50 basis points to check nagging inflationary pressures fuelled by obstinately high credit growth.
For the second time since December the Central Bank tightened its policy rates, raising the Standing Deposit Facility (SDF) rate and the Standing Lending Facility Rate (SLFR) to 7.00% and 8.50% respectively, despite giving little prior indication of its intentions.
Private sector credit growth stayed near a four-year high of 28% in May from a year earlier, hardly slowing from 28.1% a year ago, while June consumer prices rose to a 32-month high of 6.0% after the government raised Value Added Tax (VAT) from 11% to 15% to tackle a soaring deficit.
“Further tightening of monetary policy is required to curb excessive demand in order to pre-empt the escalation of inflationary pressures and to support the balance of payments,” the Central Bank said in a statement.
“The Board is of the view that tightening of monetary policy in a forward looking manner will ensure the maintenance of inflation at mid-single digits in the medium term, which is supportive of the growth momentum in the economy. As such, the current policy adjustment is not expected to have a significant impact on the long end of the yield curve. The Central Bank will continue to monitor macroeconomic developments closely and make appropriate adjustments to the monetary policy stance, as necessary,” it added.
It also said provisional data indicated the high growth of credit to the private sector had continued in June as well.
“The continued appetite for bank credit by the private sector, in spite of the upward movement in market interest rates, could create excessive demand and high inflation in the economy in future. The sustained increase in domestic credit also caused a wider trade deficit. Accordingly, the cumulative trade deficit during the first five months of 2016 registered an increase of 1.4%, year-on-year. Increased earnings from tourism and other services exports, workers’ remittances, and long term financial flows to the government, eased the pressure on the balance of payments to some extent.”
The International Monetary Fund (IMF) last month said further tightening could be needed, depending on credit and inflation developments but New Central Bank Governor Indrajit Coomaraswamy earlier this month expressed confidence that credit growth is slowing due to monetary tightening measures taken early this year.
Sri Lanka’s finances are in a precarious situation because of high external debt, partly due to heavy infrastructure borrowing under the previous Government.
The IMF has urged Sri Lanka to reduce its fiscal deficit, raise Government revenue and improve its foreign exchange reserves, which stood at $5.27 billion by the end of June, down more than a third from October 2014, under a $1.5 billion Extend Fund Facility (EFF) approved two months ago.
Sri Lanka’s first-quarter growth rose to 5.5% on the year, more than double the pace of the previous quarter, helped by a recovery in the construction industry.
However, the Central Bank remained optimistic of Sri Lanka’s growth opportunities, insisting that major sectors would continue to perform.
“The available indicators suggest a continuation of the growth momentum in economic activity. In particular, power generation, tourism and port related services, construction sector, investment goods imports as well as the Purchasing Managers’ Indices (PMI) for manufacturing and services sectors have shown improvements over the past few months.”