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Colombo: Sri Lanka’s central bank unexpectedly cut interest rates by 25 basis points on Wednesday, aiming to stimulate economic recovery after the country’s worst financial crisis in decades.
The central bank said the decision was taken in the absence of “significant inflationary pressures” and expected inflation to remain below its 5% target in the medium term.
The Central Bank of Sri Lanka (CBSL) has cut the standing deposit rate to 8.25% and the standing lending rate to 9.25%.
Nine of 14 economists and analysts polled by Reuters predicted the central bank would keep interest rates unchanged as a hedge against political uncertainty. The rest of the respondents predicted a rate cut.
“We expect inflation to remain below our target of 5% over the next six months and may even fall short of our expectations. We hope that this rate cut will help boost economic growth,” CBSL President P. Weerasinghe said at a press conference after the decision to cut rates.
He said Sri Lanka, which defaulted on its external debt in May 2022, was also making “good progress” in completing a $12.5 billion debt restructuring with bondholders.
The central bank cut interest rates by 50 basis points in March, entering an easing cycle that has seen rates fall by 7.25 percentage points since June 2023, partially reversing a 10.50 percentage point hike since April 2022, when the island was dealing with an economic collapse.
This year’s growth is expected to be 3%
With the help of a $2.9 billion loan program from the International Monetary Fund, Sri Lanka’s economy is expected to grow 3% in 2024. The country’s economy shrank 7.3% in 2022 and 2.3% last year.
Inflation fell to 1.7% in June, a sharp contrast to 70% in September 2022, at the height of the financial crisis.
Sri Lanka this month cut electricity tariffs by 22.5% and reduced fuel and cooking gas prices to lower the cost of living, a move analysts said was also in line with CBSL’s growth plans.
“They are taking advantage of the technical situation where inflation is still below the bottom of the inflation target band, coupled with the reduction in electricity prices, to lower interest rates,” said Thilina Panduwawala, research director at Frontier Research.
“Besides, they hope that the rate cut will help consolidate the pick-up in private sector credit growth seen in May and June.”
However, the rate cut is unlikely to boost economic growth beyond the expected 3% and markets are likely to keep a close eye on Sri Lanka’s upcoming presidential election, which is likely to be held before mid-October.
“The uncertainty caused by the three-way race in the presidential election will continue to affect the market,” Panduwawala said.
The vote is likely to be between President Ranil Wickremesinghe, Opposition Leader Sajith Premadasa and Marxist MP Anurad Kumara Dissanayake.
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