Sri Lanka better equipped than before to absorb oil shocks: CB Governor

• Cites strong US$ 7bn foreign reserve buffer and low inflation as critical safeguards
• Says exchange rate functions as a “shock absorber” under the flexible inflation-targeting framework, while cost-reflective fuel pricing helps prevent the fiscal deficit from widening

By Shabiya Ali Ahlam

Sri Lanka is better equipped than during its 2022 financial crisis to absorb shocks from rising oil prices, Central Bank Governor Dr. Nandalal Weerasinghe said, citing a strong US$ 7 billion foreign reserve buffer and low inflation as critical safeguards.

With inflation at the end of last month standing at 1.6 percent, compared with the Central Bank’s target of 5 percent, Dr. Weerasinghe confidently expressed that this gives Sri Lanka sufficient space to absorb a price shock of that nature into domestic inflation.

“I do not have a specific threshold to say this is the exact level we can tolerate, but we are far better prepared than we were in the past. During the crisis, inflation was extremely high. If a similar shock had occurred under those conditions, it would have been very difficult to manage.

“…for a small economy like ours that relies on imported oil, there will inevitably be some impact on both the balance of payments and inflation. However, we believe we can manage it because we have been building buffers,” Dr. Weerasinghe told Bloomberg at the sidelines of the ‘IMF Conference: Asia 2050’ in Bangkok over the weekend.

He added the exchange rate functions as a “shock absorber” under the flexible inflation-targeting framework, while cost-reflective fuel pricing helps prevent the fiscal deficit from widening.

Brent crude rose past US$ 93 a barrel on Friday as escalating tensions in the Middle East threaten supplies. Qatar’s Energy Minister Saad al-Kaabi recently cautioned that Gulf production halts could “bring down global economies,” reflecting the far-reaching consequences of a prolonged conflict.

Dr. Weerasinghe went on to draw a sharp distinction between the current situation and the crisis of 2022, when fuel shortages occurred because Sri Lanka lacked sufficient foreign exchange to buy petroleum, regardless of price.

“Today, the issue is not a lack of foreign exchange, but rather potential global supply disruptions. As long as petroleum is available in global markets, Sri Lanka has the resources to purchase it. So the challenge now relates more to external supply conditions rather than our ability to pay,” he said.

Despite external headwinds, Sri Lanka’s domestic economy shows resilience. Real GDP growth is currently around 5 percent, well above earlier projections of roughly 3 percent.

The Governor cautioned, however, that a prolonged Middle East conflict could increase freight costs and disrupt supply chains, representing the biggest risk to the economy.

Stressing that the impact is not only for Sri Lanka but for the global economy, he noted that countries must prepare for different scenarios and be ready for adverse outcomes by strengthening their buffers, whether in monetary policy, fiscal policy or external sector reserves.

When asked how a stronger dollar affects Sri Lanka, given its reliance on imported oil, Dr. Weerasinghe acknowledged it is “certainly a challenge.”

He said the cost-reflective pricing mechanism for fuel helps prevent a burden on the fiscal side, while a flexible exchange rate regime absorbs part of the external shock.

“Since our external position is much stronger now, the Central Bank can intervene if necessary to maintain orderly market conditions,” he added. “Excessive volatility in the exchange rate is harmful for any economy. Our goal is to allow the exchange rate to adjust gradually while preserving stability.”

Rounding out the policy picture, Weerasinghe discussed Sri Lanka’s IMF programme. Talks are underway to combine the fifth and sixth reviews of the US$ 3 billion Extended Fund Facility (EFF), originally delayed due to Cyclone Ditwah.

The combined review is expected to go to the IMF Executive Board around May, with flexibility to adjust targets to reflect both domestic climate impacts and global developments.