Sri Lanka maintains rate to stabilize economy, markets

December 27, 2018

By CentralBankNews.info
     Sri Lanka’s central bank kept it policy rates steady, saying the current monetary policy stance is appropriate to stabilize overall economic conditions and domestic financial markets despite subdued inflation and economic growth that remains below its potential level.
     The Central Bank of Sri Lanka (CBS), which in November lowered banks’ reserve requirements to boost liquidity but also raised its two policy rates to maintain a neutral policy stance, added the decision to keep rates steady today came amid an uptick in private sector credit and continued pressure on external reserves.
      CBS kept its Standing Deposit Facility Rate (SDFR) at 8.0 percent, the Standing Lending Facility Rate (SLFR) at 9.0 percent, and the Statutory Reserve Ratio (SRR) at 6.0 percent. In November CBS raised SDRF by 75 basis points and SLFR by 50 points.
      Last month’s 150 basis point cut in SRR freed up around 90 billion rupees in liquidity but the central bank said the liquidity deficit continued to widen and it had continued open market operations to manage liquidity on an overnight, short-term and long-term basis.
      Despite tight liquidity, CBS said annual growth of credit to the private sector has accelerated since September, partly reflecting anticipation by the private sector of measures by the government and central bank to curb excessive import growth.
     Sri Lanka’s trade deficit widened further in the first 10 months of the year despite measures to curb imports of motor vehicles, non-essential goods and a fall in the rupee’s exchange rate.
     Sri Lanka’s rupee has been falling sharply since September, depreciating by 15.9 percent against the U.S. dollar this year as of Dec. 27, the central bank said, adding gross official reserves amounted to 7.0 billion at the end of November, enough to pay for 3.7 months of imports, down from US$7.9 billion at the end of October.
     Sri Lanka’s headline inflation rate rose slightly to 3.3 percent in November from 3.2 percent in October and core inflation also remains subdued, CBS said, adding it expects inflation on average to remain below 5 percent in 2019 and stabilize in a range of 4 – 6 percent thereafter.
      Sri Lanka’s economy grew by a modest 2.9 percent year-on-year in the third quarter of the year, down from 3.6 percent in the second quarter and data shows that economic growth will continue to be low in the fourth quarter before picking up gradually next year, CBS said.

     The Central Bank of Sri Lanka issued the following statement:
 

“The Monetary Board of the Central Bank of Sri Lanka, at its meeting held on 27 December 2018, decided to maintain policy interest rates at their current levels. Accordingly, the Standing Deposit Facility Rate (SDFR) and Standing Lending Facility Rate (SLFR) of the Central Bank will remain at 8.00 per cent and 9.00 per cent, respectively. The Board considered current and expected developments in the domestic economy and the domestic financial markets as well as the global economic environment, with the broad aim of stabilising inflation at mid single digit levels in the medium term to enable the economy to achieve its potential growth.

Subpar economic growth continued in the third quarter of 2018 as well
As per the provisional estimates of the Department of Census and Statistics (DCS), the Sri Lankan economy recorded a modest real GDP growth of 2.9 per cent, year-on-year, during the third quarter of 2018, compared to the revised growth of 3.6 per cent in the second quarter of 2018. As per the available economic indicators and other economic developments, real GDP growth is likely to be low in the fourth quarter of 2018 as well, before picking up gradually in 2019. The continued low economic growth reemphasises the need for implementing broad based structural reforms without further delay.

Notwithstanding the elevated market interest rates and rupee liquidity deficit, private sector credit growth accelerated
The reduction of the Statutory Reserve Ratio (SRR) at the last monetary policy review in November 2018 released around Rs. 90 billion of rupee liquidity to the banking system. However, the liquidity deficit has widened thereafter, and the Central Bank continued its open market operations (OMOs) cautiously to manage liquidity on overnight, short term and long term basis as appropriate. Given high credit growth and foreign exchange market developments, overnight interest rates in the money market have been maintained close to the upper bound of the policy rate corridor. Other market interest rates remained at elevated levels, both in nominal and real terms.
In spite of the increased cost of funds and tight liquidity conditions, the year-on-year growth of credit to the private sector accelerated since September 2018, partly reflecting the private sector advancing its activities in anticipation of measures by the government and the Central Bank to curb excessive import growth. Nevertheless, with the contraction in net foreign assets of the banking system, the year-on-year growth of broad money (M2b) remained within the expected levels.

Favourable outlook for inflation in the near term
Headline inflation, based on both the National Consumer Price Index (NCPI) and the Colombo Consumer Price Index (CCPI), remained in low single digit levels. Core inflation also remained subdued thus far in 2018. Recent downward adjustments to fuel prices and selected administratively determined prices, as well as the reduction of Special Commodity and telecommunication levies, along with the ongoing recovery in the agriculture sector are expected to impact favourably on inflation in the near term. Volatile global commodity prices, possible weather related disruptions to domestic supply chains due to unpredictable weather patterns, and the possible pass-through of the effect of the rupee depreciation in recent months to domestic prices pose risks to the inflation outlook. The current projections show that inflation, on average, will remain below 5 per cent in 2019 and stabilise in the range of 4-6 per cent thereafter with appropriate policy adjustments.

External sector continues to face international and domestic headwinds
The trade deficit widened further in the first ten months of 2018 with the expansion in import expenditure outpacing the growth of export earnings. However, a moderation in import expenditure is expected, in response to the measures adopted to curb imports of motor vehicles and non-essential goods as well as the impact of the depreciation of the rupee. While earnings from tourism continued to grow, a slowdown in workers’ remittances was observed. In the financial account, both the government securities market and the Colombo Stock Exchange experienced net outflows of foreign investment, although marginal inflows have been observed in December. The widening trade deficit, tight conditions in the global markets and excessive speculation in the domestic market exerted pressure on the exchange rate, and the Sri Lankan rupee depreciated by 15.9 per cent against the US dollar thus far during 2018 up to 27 December. Meanwhile, gross official reserves amounted to US dollars 7.0 billion at end November 2018, providing an import cover of 3.7 months.


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Policy interest rates maintained at current levels
Although inflation remains subdued and economic growth remains below potential, the Monetary Board of the Central Bank was of the view that it is appropriate to continue the current monetary policy stance to stabilise overall economic conditions and domestic financial markets in a context where there has been an uptick in private sector credit as well as continued pressure on external reserves. 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.”

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