CB seen holding rates to support economy

REUTERS: Sri Lanka’s Central Bank is expected to keep its key interest rates steady tomorrow, as it walks a tight rope between supporting an economy hampered by the worst flooding in over a decade and keeping inflation in check amid still-strong credit growth.

A Reuters poll showed that policymakers will look past advice from the International Monetary Fund to further tighten rates. All 12 economists in the survey predicted the Central Bank would keep its standing deposit facility rate (SDFR) and standing lending facility rate (SLFR) unchanged at 7.25 percent and 8.75 percent, respectively. They also forecast the statutory reserve ratio (SRR) to stay at 7.50 percent. The IMF said last month further monetary policy tightening in Sri Lanka ‘is desirable’ until there are clear signs that inflationary pressures are subsiding, and called for more measures to curb strong credit growth. “I think the Central Bank could continue to hold rates with inflation and credit growth trending downwards,” said Shiran Fernando, an economist with Colombo-based Frontier Research.

“They will be cautious and mindful given the recent IMF statement as well.”

The Central Bank tightened monetary policy four times since December 2015 through March this year to fend off pressure on the fragile rupee and curb stubbornly high credit growth that had pushed up inflation.

Those measures have had some impact, with annual private sector credit growth of 18.9 percent in May slowing from April’s 20 percent and well off a near four-year high of 28.5 percent hit in July 2016.
Consumer inflation has also cooled to 4.8 percent in July from a year earlier, from the previous month’s 6.1 percent.

The trouble is that underlying credit growth remains solid and threatens to push up inflation again, although another policy tightening could undermine an economy that has taken a knock from extreme weather conditions - the most severe drought in 40 years in the first quarter and the worst flooding in 14 years.

The rate increases have dragged on the US$81 billion economy, which grew at an annual pace of 3.8 percent in the quarter ended March 2017, its weakest since the second quarter last year.

Danushka Samarasinghe, research head at Softlogic Stockbrokers said raising policy rates now could have an adverse impact on the government’s economic growth and fiscal goals this year.

Analysts expect 2017 growth will significantly undershoot the central bank’s forecast of between 4.5 and 5 percent, although Prime Minister Ranil Wickremesinghe said last week that he still sees 5 percent growth for the year.

The Sri Lankan rupee fell 3.9 percent in 2016 and has slipped around 2.6 percent so far this year, pressured by dollar demand from importers and foreign fund outflows from government securities on the back of rising interest rates in the United States.

The Central Bank has also stopped defending the rupee after it missed an end-December reserve target set by the International Monetary Fund for a US$1.5 billion loan.