Sri Lanka central bank unexpectedly raises policy rate by 50 bps

Sri Lanka's central bank raised its main interest rates by 50 basis points each on Thursday in a surprise move aimed at curbing stubbornly high credit growth that is adding to concern about inflationary pressures. The Central Bank of Sri Lanka raised the standing deposit facility (SDF) rate and the standing lending facility rate (SLFR) to 7.00 percent and 8.50 percent, respectively.
The third tightening measure since December follows private sector credit growth staying near a four-year high of 28 percent in May, while June consumer price inflation rose to a 32-month high of 6.0 percent. "Further tightening of monetary policy is required to curb excessive demand in order to pre-empt the escalation of inflationary pressures and to support the balance of payments," the central bank said in a statement.
It also said provisional data indicated the high growth of credit to the private sector had continued in June as well. "The continued appetite for bank credit by the private sector, in spite of the upward movement in market interest rates, could create excessive demand and high inflation in the economy in future."
The central bank raised both rates by 50 basis points in February after increasing the statutory reserve ratio (SRR) by 150 basis points on December 30. Twelve out of 13 economists had expected the bank to leave rates steady. The central bank said it did not expect the hike to have a significant impact on the long end of the yield curve. The IMF last month said further tightening could be needed, depending on credit and inflation developments.
Sri Lanka's finances are in a precarious situation because of its high external debt, partly due to heavy infrastructure borrowing under the previous government. New Central Bank Governor Indrajith Coomaraswamy said this month that credit growth is slowing due to monetary tightening measures taken early this year. "The first meeting under the new governor has taken a forward outlook on rates with the primary concern surrounding credit growth and inflation," said Shiran Fernando, an analyst at Colombo-based Frontier Research.
The IMF has urged Sri Lanka to reduce its fiscal deficit, raise government revenue and improve its foreign exchange reserves, which stood at $5.27 billion as of the end of June, down more than a third from October 2014. Sri Lanka's first-quarter growth rose to 5.5 percent on the year, more than double the pace of the previous quarter, helped by a recovery in the construction industry.