Central Bank stays its hand

The Central Bank of Sri Lanka announced that it would maintain its current policy rates in April as liquidity circumstances improved as a result of dollar purchases by the central bank, as well as a steady decline in sterilisation in the private sector. Private credit is still in the red, and state-run energy companies are pricing their production on the market, which is further reducing demand.

The Monetary Board affirms its ongoing commitment to restoring price stability and expresses its continued confidence that inflation will follow the projected disinflationary course supported by the current monetary policy stance, assisting the economy in medium-term growth. The Central Bank’s Standing Lending Facility Rate (SLFR) and Standing Deposit Facility Rate (SDFR), both of which are currently set at 15.50% and 16.50%, respectively, is expected to keep course. 

 The Board also expressed that given the better market sentiment and the decline in high risk premia, there is enough room for a further downward adjustment in market interest rates. Despite the rise in policy interest rates at the beginning of March 2023, both deposit and lending interest rates have been on the decline ever since. This is due to the Central Bank’s market guidance and the better liquidity conditions of the domestic money market. 

The Board is still prepared to take appropriate action and ensure that the interest rate structure returns to normal as soon as the price pressures on the economy are sufficiently under control in the coming term. 

According to the estimates of GDP, the economy experienced its deepest economic recession since independence in 2022, when a broad-based contraction of 7.8%, year over year, was recorded. The economy is expected to gradually rebound toward the end of 2023, helped by improvements in domestic supply conditions, an uptick in investor and business confidence, improved foreign exchange inflows, an anticipated decline in market interest rates, and the effects of policy measures being put in place to improve the outlook for growth.  

Due to the improvements in market sentiment, there was also a noticeable moderation in the yields on government assets. The large risk premia attached to the Government securities are anticipated to dissipate in the near term as a result of the public disclosure of the larger outline of the planned domestic debt optimisation operation. 

This will allow other market interest rates that are benchmarked to the yields on government securities to moderate further. The amount of foreign assets has increased from $ 2.2 billion to $ 2.7 billion adding Rs. 160 billion to the banking system through the ad hoc peg.

The anticipated disinflation process will be ensured in the coming months, backed also by anchored inflation expectations, thanks to the subdued aggregate demand as a result of strict monetary and fiscal policies and improved domestic supply conditions. Accordingly, it is anticipated that by the end of 2023, headline inflation will be in the single digits before medium-term stabilisation at the desired levels.

According to estimates, the external current account deficit decreased significantly in 2022, mainly as a result of a decrease in the trade deficit brought on by strong export earnings and a significant decrease in import expenditure. Additionally, 2023 has seen a sustained improvement in workers’ remittances, and given the increase in migration for jobs abroad, this trend is anticipated to continue. With the current tourist arrivals season still in effect, the tourism industry has seen a noticeable increase.

In addition to providing a comprehensive policy reform package with a specific execution timetable, the IMF program is anticipated to unlock a sizable amount of funding from other international financial institutions. These funds are intended to stabilise the economy and strengthen the country’s development potential. 

Given these developments and in an effort to let the market determine the exchange rate, the Central Bank stopped providing daily exchange rate guidance and, as of the beginning of March 2023, revoked the requirement that converted export proceeds and worker remittances be sold for foreign currency.