Sri Lanka Holds Rates As Focus Turns To Reforms To Stabilise Crisis-hit Economy

Sri Lanka's central bank held policy rates steady on Thursday, saying monetary conditions remain "sufficiently tight" after a massive rate-hike campaign earlier in the year as the crisis-hit nation grapples with red-hot inflation and shortage of dollars.

As widely expected, the Standing Lending Facility rate was held steady at 15.50% while the Standing Deposit Facility Rate was kept unchanged at 14.50%.

The South Asian island of 22 million people is battling its worst economic crisis since independence from Britain in 1948, with a plunge in the rupee currency, runaway inflation and an acute dollar shortage to pay for essential imports of food, fuel and medicine.

Nine out of 14 economists and analysts polled by Reuters had forecast rates to remain unchanged, after the Central Bank of Sri Lanka's (CBSL) aggressive tightening campaign saw rates raised by a total 950 basis points so far in 2022.

Graphic: Sri Lanka Cenbank's Key Lending and Deposit Rates

"Monetary conditions remain sufficiently tight to achieve the envisaged disinflation path in the period ahead," CBSL said in its statement.

"The contractionary fiscal policies would complement the effects of tight monetary policy measures already in place, helping to mitigate any build-up of aggregate demand pressures, thereby anchoring inflation expectations and bringing down headline inflation to the targeted level of 4-6% over the medium term," they added.

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For now, however, inflation remains uncomfortably high, hitting a record of 68.9% in September year-on-year with food inflation up 93.7%, exacerbated by the rupee currency's dive and a global surge in commodity prices.

"The key factor ahead is the 2023 budget and tax proposals which will support demand pressure, but also impact growth momentum to some extent," said Lakshini Fernando, a senior economist at investment firm Asia Securities.

Sri Lanka's economy is in a deep slump, shrinking an annual 8.4% in the June quarter in one of the steepest quarterly declines amid fertiliser and fuel shortages. The central bank is predicting an 8.7% GDP contraction for 2022.

Earlier this year, Sri Lanka defaulted on its foreign debt for the first time in history.

Fernando said the focus would be on the policies the government announces to bring down debt to sustainable levels, a key criteria for securing a bailout package from the International Monetary Fund.

"We know there are a number of tax measures coming up in the upcoming budget, but with real consumer spending already impacted with high inflation, further tax increases will dampen economic momentum to some extent," Fernando said.

Sri Lanka expects the IMF board to approve a $2.9 billion loan by year-end, officials from the country's central bank told investors during a virtual presentation in late September, sources participating in the event said.

"A recovery in economic activity is expected in 2023 with the envisaged improvements in the supply-side, along with the timely implementation of the required reforms," CBSL said.