Sri Lanka becomes first in Asia to raise interest rate in pandemic-era

The Central Bank of Sri Lanka (CBSL) became the first in Asia on Thursday to raise interest rates since the pandemic began, as it acted to stem inflationary pressure and high imports, one of the factors behind the rupee’s 8 per cent depreciation this year.

The central bank increased the standing deposit facility rate and the standing lending facility rate by 50 basis points each to 5 per cent and 6 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. The Sri Lankan economy is gradually making headway after the negative impact of the coronavirus pandemic in 2020 and is poised to record a higher growth rate during the second quarter of 2021, partly due to the base effect, the CBSL said.

But it also cautioned that there could be some weakness in the second half due to further outbreaks of infections.

Inflation in recent months has accelerated due to higher food prices and some uptick in non-food inflation, and the CBSL projects it to hover around the upper bound of the 4-6% target range in the near term. The July Colombo consumer price based inflation rose 5.7 per cent compared with June’s 5.2 per cent, latest data showed.

Sri Lanka sovereign dollar bonds surged after the rate increases while the CSE All share index fell 1 per cent.

“The policy rate hike has likely been taken as a measure to mitigate excessive pressures on the currency, even though the CBSL’s official rate hasn’t changed yet,” said Trisha Peries, head economist research at Frontier Research.

The 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.