Sri Lanka policy rates unchanged amid exchange rate pressure
COLOMBO (EconomyNext) – Sri Lanka’s central bank said it will keep policy rates unchanged amid low inflation despite the exchange rate coming under pressure with stronger state and private credit.
Sri Lanka’s inflation rose only 0.1 percent in the 12-months to April, but some of the fall in the index came from tax cuts, which had in turn expanded the deficits at the central government and state petroleum utility, pressuring the monetary system.
"Going forward, with improved domestic supply conditions and subdued prices of key commodities in the international market, it is projected that inflation would remain at low levels in the months ahead," the Central Bank said in its May monetary policy statement.
In March, banks had disbursed 41.4 billion rupees in credit to the private borrowers.
"Given continued low market interest rates, it is projected that private sector credit would increase further in the period ahead supporting the growth momentum of the economy," the statement said.
The Central Bank said it will keep policy rate corridor at 6.00 percent to drain excess liquidity and 7.50 percent to inject overnight funds.
Analysts had warned that Sri Lanka’s low interest rates were incompatible with an expanded budget deficit and growing private credit which would pressure the exchange rate by creating an imbalance between the credit demand and deposit generation of banks.
The rupee had already been allowed to depreciate 2.0 percent so far this year by the Central Bank.
But the monetary authority said the external picture would improve rather than deteriorate.
"In the external sector, the recent currency swap agreement with the Reserve Bank of India amounting to US dollars 400 million has strengthened official reserves of the country," the Central Bank said.
"The realisation of expected capital inflows in the period ahead and sustained regular inflows in the form of earnings from the export of goods and services, including tourism and workers’ remittances would improve the balance of payments during the year."
Analysts however had pointed out that all inflows will eventually generate a similar amount of imports provided credit is strong and any net pressure on the exchange rate comes from liquidity released by the central bank.