The Central Bank of Sri Lanka (CBSR), which raised its two key rates by 100 basis points last year to slow growth in private sector credit, added its decision took into account the improvement in fiscal operation that resulted in the budget deficit last year narrowing to expected levels.
"The board was of the view that these improvements, together with the substantial upward movements already observed in market interest rates, have reduced the required adjustment in policy interest rates," the central bank said.
The central bank raised its Standing Deposit Facility Rate (SDFR) to 7.25 percent and the Standing Lending Facility Rate (SLFR) to 8.75 percent.
The rate rise was not unexpected and comes only weeks after the International Monetary Fund (IMF) said the central bank should remain vigilant and be ready to tighten its policy stance if inflation or credit growth didn't ease.
Sri Lanka's inflation rate has been ticking up in the last two months and hit 6.8 percent in February, the highest rate since June 2013, as drought affected the cost of food while non-alcoholic beverages also rose 7.7 percent and transportation prices rose 5 percent.
The central bank said it expects inflation to revert to its desired mid-single digit levels and then stabilize unless inflation expectations accelerate.
The central bank is slowly moving towards a flexible inflation targeting framework that calls for inflation in a range of 4-6 percent in the medium term, a range that is consistent with the inflation target bands that have been set out under its arrangement with the IMF.
Private sector credit decelerated further to 20.9 percent in January from 21.9 percent at the end of last year while credit to the public sector remained strong, pushing up the growth of broad money (M2) to 17.7 percent in January, down from 18.4 percent in December.
"Nevertheless, the declaration in monetary and credit aggregates has been slower than expected," the central bank said.
Sri
Lanka's rupee has been depreciating in several steps since October 2011 and has
been falling steadily since August 2015 and was trading at 152.2 to the U.S.
dollar today, down 2.5 percent this year and down 5.3 percent since the start
of 2016.
"As per the provisional estimates of the Department of Census and Statistics (DCS), the Sri
Lankan economy grew by 4.4 per cent in real terms during 2016 compared to the growth of 4.8 per cent
in 2015. Within this annual growth, Industry related activities grew notably by 6.7 per cent driven by
construction related activities, while Services related activities grew by 4.2 per cent mainly with the
expansion of financial services, insurance and telecommunications. However, Agriculture related
activities contracted by 4.2 per cent in 2016, impacted by supply side disruptions on account of floods
in the second quarter and drought conditions during the final quarter of 2016. In spite of challenging
external factors such as adverse weather conditions and global developments, an acceleration of growth
was observed towards end 2016 with the last quarter of 2016 recording a growth of 5.3 per cent, partly
supported by the base effect.
In the meantime, headline inflation, as measured by the year-on-year change in the Colombo Consumers’ Price Index (CCPI, 2013=100), accelerated to 6.8 per cent in February 2017 from 5.5 per cent in January 2017. A similar trend was observed in the National Consumer Price Index (NCPI, 2013=100) based headline inflation, which rose to 8.2 per cent (year-on-year) in February 2017 from 6.5 per cent in January 2017. Year-on-year core inflation based on both CCPI and NCPI also remained high at 7.1 per cent in February 2017. The recent acceleration in inflation is largely due to the impact of prevailing drought conditions and adjustments to the tax structure, and it is projected that inflation would revert to the desired mid single digit levels in the period ahead and stablise thereafter, unless disrupted by adverse inflation expectations.
Considering the above developments, the Monetary Board, at its meeting held on 23 March
2017, was of the view that further tightening of monetary policy is necessary as a precautionary
measure, in order 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 Monetary
Board also took into account the notable improvements in fiscal operations, which have resulted in the
overall budget deficit in 2016 declining to envisaged levels. The Board was of the view that these
improvements, together with the substantial upward movements already observed in market interest
rates, have reduced the required adjustment in policy interest rates.
Accordingly, the Monetary Board decided to increase the key policy interest rates of the Central Bank, namely the Standing Deposit Facility Rate (SDFR) and the Standing Lending Facility Rate (SLFR) by 25 basis points each, to 7.25 per cent and 8.75 per cent, respectively, with effect from 24 March 2017."
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In the meantime, headline inflation, as measured by the year-on-year change in the Colombo Consumers’ Price Index (CCPI, 2013=100), accelerated to 6.8 per cent in February 2017 from 5.5 per cent in January 2017. A similar trend was observed in the National Consumer Price Index (NCPI, 2013=100) based headline inflation, which rose to 8.2 per cent (year-on-year) in February 2017 from 6.5 per cent in January 2017. Year-on-year core inflation based on both CCPI and NCPI also remained high at 7.1 per cent in February 2017. The recent acceleration in inflation is largely due to the impact of prevailing drought conditions and adjustments to the tax structure, and it is projected that inflation would revert to the desired mid single digit levels in the period ahead and stablise thereafter, unless disrupted by adverse inflation expectations.
The earlier tightening of monetary policy and monetary conditions by the Central Bank and the
resultant increase in market interest rates are likely to have impacted the growth of credit to the private
sector by commercial banks to some extent. Accordingly, the year-on-year growth of private sector
credit decelerated further to 20.9 per cent in January 2017 from 21.9 per cent at end 2016. Meanwhile,
credit to the public sector increased noticeably, causing year-on-year broad money (M2b) growth to
remain high at 17.7 per cent in January 2017, although this was a deceleration compared to 18.4 per
cent in December 2016. Nevertheless, the deceleration in monetary and credit aggregates has been
slower than expected.
On the external front, the deficit in the trade account of the balance of payments (BOP) was recorded at US dollars 9.1 billion in 2016 compared to US dollars 8.4 billion in 2015, with expenditure on imports increasing by 2.5 per cent and earnings from exports contracting by 2.2 per cent during the year. Provisional data for January 2017 also indicated a widening of the trade deficit. Earnings from tourism and workers’ remittances continued to cushion the adverse impact of the trade deficit on the BOP. In the meantime, outflows of foreign investments from the government securities market observed in early 2017 appear to have subsided, and marginal inflows have been experienced in spite of the increase in policy interest rates in the United States. Gross official reserves were estimated at US dollars 5.6 billion at end February 2017 compared to US dollars 6.0 billion at end 2016, while the Sri Lankan rupee depreciated by 1.2 per cent against the US dollar during the year up to 22 March 2017.
On the external front, the deficit in the trade account of the balance of payments (BOP) was recorded at US dollars 9.1 billion in 2016 compared to US dollars 8.4 billion in 2015, with expenditure on imports increasing by 2.5 per cent and earnings from exports contracting by 2.2 per cent during the year. Provisional data for January 2017 also indicated a widening of the trade deficit. Earnings from tourism and workers’ remittances continued to cushion the adverse impact of the trade deficit on the BOP. In the meantime, outflows of foreign investments from the government securities market observed in early 2017 appear to have subsided, and marginal inflows have been experienced in spite of the increase in policy interest rates in the United States. Gross official reserves were estimated at US dollars 5.6 billion at end February 2017 compared to US dollars 6.0 billion at end 2016, while the Sri Lankan rupee depreciated by 1.2 per cent against the US dollar during the year up to 22 March 2017.
Accordingly, the Monetary Board decided to increase the key policy interest rates of the Central Bank, namely the Standing Deposit Facility Rate (SDFR) and the Standing Lending Facility Rate (SLFR) by 25 basis points each, to 7.25 per cent and 8.75 per cent, respectively, with effect from 24 March 2017."
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