Inflation to slow to 6% by year-end

• Rupee currency to keep appreciating on inflows
• Economy has capacity to absorb demand pressure - CBank
• Cenbank expects credit growth to slow below 30 pct

By Shihar Aneez

(Reuters):  Sri Lanka’s annual and annual average inflation should settle to around 6 percent by the year’s end despite demand pressure caused by resurgent economic growth two years after the island nation won a 25-year civil war, the Central Bank said on Friday.

Sri Lanka’s rupee will also keep appreciating due to strong remittances and investment, Central Bank Chief Economist K.D. Ranasinghe said. Exporters, particularly in the nation’s core tea and garment industries, have increasingly complained of the rupee’s strength.

Sri Lanka’s annual inflation surprisingly rose in July to 7.5 percent from a year earlier while annual average inflation accelerated to 7.0 percent last month, highest in the new index.

Core annual inflation, which excludes fresh food, energy, transport, rice and coconut, rose to a seven-month high of 8.9 percent from 8.7 percent a month ago, which Ranasinghe said showed hints of demand pressure on the $50 billion economy.

          “But we don’t see any significant pressure and still we hope by end of this year, both annual and annual average inflation will be around 6 percent,” Ranasinghe told Reuters in an interview.

The island nation revised up its annual average inflation target to 7 percent in March from 6 percent under an old index, which the government revamped in June by removing the most volatile elements and reflecting more modern consumer spending.

The economy turned in the highest growth in 32 years in 2010, 8 percent, and the government has forecast it will hit a record 8.5 percent this year.

The International Monetary Fund (IMF), which is overseeing a $2.6 million loan programme to help Sri Lanka rein in spending and create sustainable growth, has forecast 7 percent expansion in 2011. First-quarter growth was 7.9 percent.

The inflation rise comes against the backdrop of the Central Bank’s loose monetary policy, with rates at their lowest in six years despite private-sector credit growth hitting a 16-year high of 33.3 percent in May, year-on-year.

Ranasinghe said provisional data shows credit growth was around 34 percent in June, but that there was still unutilised expansion capacity left to fill before it becomes a worry.

“We think that there is a capacity to increase in credit without significantly pressurising the demand. We expect it will go below 30 pct,” he said.

A rise in imports, mainly due to aircraft purchases by Sri Lanka’s national airline and higher oil price, have caused the trade deficit to surge 50 percent year-on-year in the first five months. The full-year estimate is 30 percent.

Higher remittances from Sri Lankan expatriate workers and an increase in the service account should help the country meet its current account deficit target of 3.7 percent of gross domestic product, Ranasinghe said.

Sri Lanka’s foreign reserves are now at a record $8.2 billion after a $1 billion eurobond sale last month, he said.