Central Bank Governor Ajith Nivard Cabraal - Pic by Lasantha Kumara 

• Ups policy rates by 50 basis points; first time after August last year
• Expects corresponding increase in interest rates, particularly in deposit rates, thereby encouraging savings while discouraging excessive consumption, which also fuels imports 
• Says anticipated adjustment in market interest rates will facilitate reduction in Treasury bill holdings of Central Bank through increased market subscriptions
• Allows private banks to finance essential import bills for fuel purchases in proportion to their foreign exchange inflows
• Mandates all registered tourist establishments to accept forex only in respect of services rendered to persons residing outside Sri Lanka
• Extends ongoing Rs. 10 per dollar incentive for channelling remittances via banking channels till end-April; to reimburse Rs. 1,000 per remittance transaction
• To offer higher interest rates for both foreign currency and rupee-denominated deposits of migrant workers
• Estimates economy grew by 4% in 2021; forecasts 5% growth this year
• Exports hit a record of $ 12.4 b in 2021; imports swell to $ 20.6 b

The Central Bank yesterday announced several policy measures including a raise in interest rates, checkmate runaway inflation and fresh incentives to boost foreign exchange reserves as part of overall objective of strengthening the macroeconomic stability.

The Monetary Board in its first meeting for the new year on Wednesday decided the following:

Increase the Standing Deposit Facility Rate (SDFR) and the Standing Lending Facility Rate (SLFR) of the Central Bank by 50 basis points each, to 5.50% and 6.50%, respectively

Distribute the financing of essential import bills for fuel purchases among the licensed banks in proportion to their foreign exchange inflows

Mandate all registered tourist establishments to accept foreign exchange only in respect of services rendered to persons residing outside Sri Lanka

Extend the payment of an additional Rs. 8 per dollar for workers’ remittances paid in addition to the incentive of Rs. 2 per dollar offered under the ‘Incentive Scheme on Inward Workers’ Remittances’ until 30 April 2022

Reimburse the transaction cost borne by Sri Lankan migrant workers through the payment of Rs. 1,000 per transaction, when remitting money to rupee accounts via licensed banks and other formal channels with effect from 1 February and introduce higher interest rates for both foreign currency and rupee denominated deposits of migrant workers

The increase in policy rates is the first since August last year. 

The Central Bank said latest measures will curtail the possible build-up of underlying demand pressures in the economy, which would also help ease pressures in the external sector, thus promoting greater macroeconomic stability. 

In keeping with this policy stance, the Central Bank expects a corresponding increase in interest rates, particularly in deposit rates, thereby encouraging savings, while discouraging excessive consumption, which also fuels imports. 

Financial institutions were urged to swiftly pass on this increase to deposit rates of the customers. The anticipated adjustment in market interest rates will facilitate the reduction in the Treasury bill holdings of the Central Bank through increased market subscriptions, as enunciated in the Six-Month Road Map for Ensuring Macroeconomic and Financial System Stability. 

CBSL also said the materialisation of the expected foreign exchange inflows through bilateral arrangements and other import financing arrangements with friendly countries are expected to ensure a healthy level of gross official reserves in the period ahead and further strengthen the external sector in the economy. 

CBSL in its statement said economic activity is expected to record a gradual recovery following a temporary setback as per the data released by the Department of Census and Statistics, domestic economic activity that was disrupted with the outbreak of the third wave of the COVID-19 pandemic and related mitigative measures is estimated to have contracted by 1.5%, year-on-year, during the third quarter of 2021. 

However, economic activity towards the latter part of 2021 appears to have gathered momentum as several leading indicators point towards activity returning to normalcy along with the successful vaccination drive of the Government. Accordingly, the economy is expected to have recorded a growth of around 4.0% in 2021 whilst the forecast for 2022 is 5%. 

External sector remains resilient amidst heightened challenges with the normalisation of global economic activity, a notable improvement in export performance was observed, with monthly exports remaining in excess of $ 1 billion, consecutively since June 2021. CBSL said exports in 2021 grew to a record $ 12.46 billion.

CBSL said expenditure on imports (estimated at $ 20.6 billion in 2021) increased significantly, partly reflecting the increased international prices, the demand for intermediate goods, and a more than expected demand for consumer goods. The increase in imports was also underpinned by the availability of low-cost credit, which led the trade deficit to widen to pre-pandemic levels in 2021. 

It also said developments in the tourism sector appear to be promising with the influx of tourists in recent months. Although inflows in the form of workers’ remittances have reduced somewhat in the latter half of 2021, the introduction of special incentive schemes and the actions taken by the authorities to curb illegal fund transfers have generated renewed interest in routing funds through formal channels. 

The rupee depreciated by 7% against the dollar in 2021 and has been broadly stable thus far in 2022. At the same time, the Central Bank was able to fulfil the timely settlement of the International Sovereign Bond (ISB) of $ 500 million on 18 January. As of end-2021, the gross official reserves were estimated at $ 3.1 billion.

Credit flows to the private sector continue to expand credit extended to the private sector, which slowed down during September and October 2021, has picked up recently, partly reflecting the increased credit flows to finance imports. 

Credit obtained by the public sector from the banking system, particularly net credit to the Government, continued to expand. Despite the recent deceleration observed due to the decline in net foreign assets of the banking system, with the significant expansion in domestic credit, the growth of broad money (M2b) remained elevated by end November 2021. 

CBSL said most market lending rates have adjusted upwards, while deposit rates have also increased albeit at a slower pace. Further, yields on Government securities have increased amidst enhanced market subscriptions at primary auctions for Government securities.

CBSL said supply side factors remain the key driver of domestic price pressures amidst the possible signs of demand pressures Inflationary pressures in the domestic front continued to be fuelled by supply side disruptions, upward adjustments to administered domestic prices, and the strengthening of underlying demand conditions in the economy as reflected in the rise in core inflation. 

Such supply driven price pressures are expected to be transitory, although the possible build-up of demand driven inflationary pressures may compel the adoption of proactive monetary policy measures, which will also help in managing inflation expectations.

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