The International Monetary Fund (IMF) has urged Sri Lanka to maintain a tightening bias on monetary policy until clear signs emerge that inflationary pressures and credit growth are moderating.
The IMF also advised the island nation’s government to push through more structural reforms to improve its fiscal health, after approving the disbursement of a US$251.4 million tranche under a three-year US$1.5 billion loan.
“Inflation and credit growth remain on the high side. Maintaining a tightening bias for monetary policy is recommended until clear signs emerge that inflation pressures and credit expansion have subsided,” Mitsuhiro Furusawa, acting chair and deputy managing director of the IMF said in a statement.
“Sri Lanka’s high debt burden, large gross financing needs, and weak financial performance of state-owned enterprises increase the importance of further fiscal consolidation.”
He said timely progress in structural reforms, including tax administration and energy pricing, will support fiscal consolidation.
The global lender also said it is important to further accumulate foreign exchange reserves and enhance exchange rate flexibility to reduce Sri Lanka’s external vulnerability along with efforts to deepen the forex market.
Sri Lanka has broadly achieved fiscal targets and most conditions agreed with the IMF for the loan. But tighter monetary and fiscal policies are already weighing on the US$81 billion economy’s growth.
However, Central Bank Governor Indrajit Coomaraswamy told Reuters last week that he does not see a need for another interest rate hike as core inflation is easing.
The annual headline inflation rate was 7.6 percent last month, slowing slightly from the previous month’s record high of 7.8 percent. But core inflation, which excludes fresh food, energy, transport, rice and coconuts, was at 5.2 percent in November, easing from the previous month’s 5.8 percent.
Since December 2015 the Central Bank has raised its key policy rates by 125 basis points (bps). Separately, the Statutory Reserve Ratio was increased 150 bps.
Those measures, as well as a tightening of fiscal policy, have dragged on activity. The central bank last month lowered its 2017 economic growth forecast to between 4 percent and 4.5 percent, from the earlier target of 4.5 percent.
The Central Bank has had to balance the need to temper price pressures while supporting an economy hit by extreme weather. The country was hit by the most severe drought in 40 years in the first quarter and the worst flooding in 14 years in May.
Sri Lanka is also facing a debt crisis with the repayment cycle of expensive infrastructure foreign loans starting next year. It has to repay over US$5 billion in the next 12 months while the country has just over US$7 billion in foreign exchange reserves.