Sri Lanka made its second consecutive interest rate cut as the country’s inflation rate begins to stabilize after a severe economic crisis, Reuters reported. The focus has now shifted toward revitalising economic growth following a bailout from the International Monetary Fund (IMF).
The Central Bank of Sri Lanka (CBSL) has reduced its standing deposit facility rate (SDFR) and standing lending facility rate (SLFR) from 13 per cent and 14 per cent to 11 per cent and 12 per cent, respectively. This 2 per cent reduction follows a 2.5 per cent cut during the previous policy meeting in June. Last year, Sri Lanka faced a crisis when it depleted its foreign exchange reserves, leading to skyrocketing food and energy prices. In July, protests resulted in the resignation of then-President Gotabaya Rajapaksa.
Tackling Inflation After Infamous Political Unrest
To combat inflation, the central bank raised interest rates by a record 950 basis points last year and increased them by an additional 100 basis points on March 3. However, President Ranil Wickremesinghe, who assumed office in July, negotiated a $2.9 billion bailout from the IMF in March to address the economic challenges.
The CBSL issued a statement urging the banking and financial sector to pass on the benefits of the monetary policy easing to individuals and businesses, thereby supporting economic activity and promoting a rebound. Sri Lanka’s key inflation index peaked at 70 per cent year-on-year in September but gradually decreased to 12 per cent in June.
Reuters cited Dimantha Mathew, the head of research at First Capital, who highlighted the CBSL’s intention to swiftly implement a domestic debt restructuring plan. He explained that with the rapid reduction of interest rates, the government would issue long-term bonds to lower borrowing costs. Mathew predicted that borrowing costs would decline to between 11 per cent and 13 per cent as rates continue to trend downward.
Factors Affecting Recovery
Although economic activity in Sri Lanka remained subdued in the second quarter of 2023, the CBSL expects a gradual recovery toward the end of the year. Factors contributing to this recovery include:
- Policy normalization
- Improved supply conditions
- Relaxation of import restrictions
- Enhanced foreign exchange liquidity
The central bank also anticipates that this recovery will gradually close the large negative output gap in the economy and lead to the attainment of the economy’s potential level of growth over the medium term.
Analysts predict that more rate cuts will occur in the coming months to support economic recovery and reduce borrowing costs for both corporations and the government. Reuters cited Thilina Panduwawala, head of research at Frontier Research, who stated that the CBSL’s confidence in the inflation trajectory and foreign inflows is instrumental in supporting the economy through lower interest rates. Panduwawala’s projection is for the SLFR to reach 10 per cent by the end of the year, implying the likelihood of two more 100 basis point cuts during the remainder of the year.
(With Inputs from Reuters)
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