Sri Lanka unexpectedly cuts rate to 14% as inflation cools

Colombo: Sri Lanka unexpectedly cut its benchmark rate for the first time in nearly three years, as a deceleration in inflation allowed policymakers room to support the nation’s economic recovery that’s gotten a lift from an International Monetary Fund bailout.

The Central Bank of Sri Lanka lowered the standing lending facility rate to 14 per cent from 16.5 per cent, according to a statement on its website on Thursday. None of the seven economists surveyed by Bloomberg had expected the move, with all predicting the rate to be kept unchanged.

“This move is expected to accelerate the normalization of the interest rate structure in the period ahead and broadbase the recovery of activity in the economy and ease pressures in the financial markets,” the central bank said in the statement.

Inflation is now projected to “decelerate notably in the period ahead, reaching single digit levels” in the early third quarter, the central bank said. Previously the monetary authority targeted the end of the year for single digit inflation while the IMF wanted to see headline CPI slow to the target band of 4 per cent to 6 per cent by early 2025.

The decision comes as price gains softened for a fourth month in May on record gains in the local currency and improving food and fuel supplies. The $3 billion IMF program, clinched in March, has helped the South Asian nation start to emerge from its worst economic crisis since gaining independence in 1948.

“The large appreciation of the exchange rate observed recently is yet to be reflected in the price levels, and it would quicken the disinflation process, as the prices of imported goods are expected to decline further,” the central bank said.

The central bank also recommended that the government consider phasing out the remaining restrictions on most items of goods imports.

The island nation’s continued recovery hinges closely on the government’s ability to restructure its debt in line with IMF criteria in order to keep unlocking funds under the program. Sri Lanka is yet to set a date to announce its restructuring blueprint that’s needed to advance negotiations with creditors.

The IMF sees Sri Lanka’s economy returning to growth next year as fresh funding is received and local authorities implement reforms to strengthen its fiscal health and price stability.

The central bank estimated that reserves have surpassed $3 billion, including the swap facility from the People’s Bank of China.

“Reflecting the improved balance of payments conditions, the central bank relaxed the cash margin deposit requirements imposed on selected imports in May 2023, and further measures will be initiated to loosen capital flow restrictions in the period ahead,” it said.