Sri Lanka’s central bank hikes rates, targets inflation despite economic contraction

COLOMBO (Reuters) – Sri Lanka’s central bank raised key interest rates to their highest in two decades on Thursday to bring down record inflation, despite the country shriveling from a devastating economic crisis.

With foreign exchange reserves at an all-time high, the island nation is struggling to pay for essentials like food, medicine and fuel. Growth has been stifled – the economy contracted 1.6% annually between January and March and is expected to have shrunk further in the second quarter.

Inflation, however, hit a record 54.6% year-on-year in June, while food inflation accelerated to 80.1%, prompting the central bank to raise rates to meet rising food prices. priority price.

The bank raised the rate on the standing lending facility by 100 basis points to 15.50%, while the rate on the standing deposit facility was similarly raised to 14.50%, the highest since. August 2001.

Chart: Sri Lanka raises interest rates,

“The board was of the view that further monetary policy tightening would be needed to contain any buildup of adverse inflation expectations,” the central bank said in a statement.

Significant progress has been made in negotiations with the International Monetary Fund (IMF) for a credit facility while negotiations are underway with bilateral and multilateral partners to secure bridge financing and ease the reserve gap, the Commission said. central bank.

“There has been a shift in central bank stance, perhaps as a result of discussions with the IMF,” said Dimantha Mathew, head of research at First Capital.

“I don’t think they care about growth at all and have focused on easing monetary pressure and printing money to stabilize the economy,” he added.

The central bank estimates a contraction in growth of 4-5% this year, with inflation expected to reach 60% by the end of the year, Prime Minister Ranil Wickremesinghe told parliament on Tuesday, although the government is aiming a weaker contraction of 1 percent. cent of growth next year.

The central bank also said ensuring external sector stability and overall macroeconomic stability would require the engagement of all stakeholders in the economy and called for consistent and coherent action, including from the government.

“A faster implementation of the expected tax reforms aimed at strengthening the rationalization of government revenues and expenditures is necessary,” he said, adding that improving the financial situation of public enterprises was also essential.

He said these measures would over time lead to a decline in the government’s financing needs and help to reduce monetary financing at a faster pace.

Sri Lanka is due to present a draft budget to parliament in August, which will include new tax measures and spending cuts, Wickremesinghe told parliament last month.

The IMF indicated the need for stronger fiscal measures to put public finances back on track and strengthen debt sustainability after a ten-day visit to the country late last month.

Sri Lanka is pushing for a possible extended $3 billion IMF financing package, which would help it unlock other bridging financing options to pay for essential imports.

Sri Lanka hopes to hold a donors’ conference with the participation of China, India and Japan after reaching a staff-level agreement with the IMF and will present its debt sustainability framework to the global lender. here august.

(Editing by Raju Gopalakrishnan)