The Central Bank of Sri Lanka (CBSL) opted to maintain its interest rates on Tuesday, in alignment with market expectations, refraining from a rate cut amid concerns about inflation. The Standing Deposit Facility Rate remains at 9%, and the Standing Lending Facility Rate at 10%, as anticipated in a Reuters poll.
The decision was driven by the aim to keep inflation at the targeted level of 5% over the medium term while facilitating the economy to reach its potential, according to a CBSL statement. The central bank acknowledged the impact of recent taxation changes and supply-side factors, which could exert upward pressure on inflation in the near term. However, it anticipates any inflationary surge this year to be short-lived.
Last year, the central bank reduced interest rates by 650 basis points as Sri Lanka navigated a challenging economic recovery from its worst financial crisis in over seven decades, with support from an International Monetary Fund (IMF) bailout. Despite improvements in the economy, the IMF emphasized the need to translate these gains into improved living conditions for the Sri Lankan population during its recent technical staff visit to the country.
At the beginning of 2024, Sri Lanka raised its value-added tax (VAT) from 15% to 18% to meet revenue targets under the four-year $2.9 billion IMF program. This move is expected to contribute to a potential rise in the country’s key inflation rate, which had eased to 4% at the end of 2023 from a high of 70% in September 2022. The CBSL anticipates the VAT increase to add 2 percentage points to the inflation rate, while analysts suggest it could contribute up to 4 percentage points.
Thilina Panduwawala, head of research at Frontier Research, highlighted the transient nature of the inflation uptick, attributing it to weather impacts on food prices and tax changes. He noted that the rate cuts implemented so far are deemed sufficient for interest rates to ease further in the current context. The CBSL stated that past monetary policy easing measures and a decline in the risk premium on government, securities create space for further reductions in market lending interest rates.
Sri Lanka faces the task of securing agreements with creditors in the coming months to navigate the second review of the IMF program, due in the first half of 2024. The country’s total external debt stands at $36.4 billion, according to the latest data from the finance ministry. Analysts expect the central bank to withhold further easing unless there are noticeable delays in external debt restructuring. Meanwhile, rates of government securities are anticipated to continue declining, especially in the short term, with improvements in the fiscal position and completion of external debt restructuring.