The Central Bank of Sri Lanka became the first in Asia on Thursday to raise interest rates since the pandemic began, as it acted to stem inflationary pressures and high imports, one of the factors behind the rupee's 8 per cent depreciation this year.
The central bank (CBSL) increased the standing deposit facility rate and the standing lending facility rate by 50 basis points each to 5.00 per cent and 6.00 per cent, respectively.
It also increased the statutory reserve ratio by 200 basis points to 4 per cent with effect from Sept. 1.
"These decisions were made with a view to addressing the imbalances on the external sector of the economy and to preempt the buildup of any excessive inflationary pressures over the medium term, amidst improved growth prospects," CBSL said in a statement.
CBSL said the Sri Lankan economy is gradually making headway after the negative impact of the pandemic in 2020 and is poised to record a higher growth rate during the second quarter of 2021 partly due to the base effect. But, it also cautioned that there could be some weakness in the second half due to further outbreaks of infections.
"Available indicators and projections suggest that the real economy would grow over 5 per cent in 2021, and this momentum could be sustained over the medium term," it said.
Inflation in recent months has accelerated due to high food inflation and some uptick in non-food inflation and CBSL projects it to hover around the upper bound of the 4-6 per cent target range in the near term.
The latest data showed the July Colombo consumer price-based inflation rose 5.7 per cent compared with June's 5.2 per cent while the National CPI had risen 6.1 per cent in June.
External sector concerns
CBSL said the stimulus measures taken after the pandemic hit the economy resulted in low-cost credit which, in turn, led to a sustained increase in imports.
"The increase in import expenditure outweighing the improvements observed in earnings from exports, the trade deficit continued to widen during the first half of 2021 over the corresponding period of last year," CBSL said.
"Moreover, the expected recovery in the tourism industry could be further delayed due to uncertainties associated with the resurgence of the pandemic globally," it added.
Tourism contributes more than 12 per cent to the country's GDP and the pandemic has dealt a major blow to foreign currency earnings.
The Sri Lankan rupee is down about 8 per cent so far this year also weighed down by the country's external debt service obligations.
The government has so far met all its external payments but worries remain over potential defaults.
"Measures are being taken by the government and the central bank to secure foreign financing from several sources in order to reinforce the level of official reserves in the near future," CBSL said.
