The Central Bank of Sri Lanka Significantly Tightens its Monetary Policy Stance to Stabilise the Economy

cbsl-moentory

Monetary Policy Review: No. 03 – April 2022

The Monetary Board of the Central Bank of Sri Lanka, at its meeting held on 08 April 2022, decided to increase the  Standing  Deposit  Facility  Rate  (SDFR)  and the  Standing  Lending  Facility  Rate (SLFR) of the Central Bank by 700 basis points to 13.50 percent and 14.50 percent, respectively, effective from the close of business on 08  April 2022.  The  Board,  having noted the inflationary pressures that could further intensify in the period ahead,  driven by the build-up of aggregate demand,  domestic supply disruptions,  exchange rate depreciation, and the elevated prices of commodities globally, was of the view that a substantial policy response is imperative to arrest the buildup of added demand-driven inflationary pressures in the economy and preempt the escalation of adverse inflationary expectations, to provide the required impetus to stabilise the exchange rate and also to correct anomalies observed in the market interest rate structure.

 

 



 

 

 

 

The external sector is facing continued heightened challenges

Although the momentum in the export sector continued with earnings exceeding US dollars 1 billion for several consecutive months, elevated levels of expenditure on imports have led to the continued widening of the trade deficit. Tourist arrivals have indicated a promising recovery, although recent geopolitical  tensions,  as  well  as  domestic  economic  uncertainty  along  with  power  and  energy outages and supply interruptions, could weigh on this recovery to some extent. Workers’ remittances are showing signs of recovery following the adjustment to the exchange rate and the continued increase in worker migrations. With greater market orientation in the determination of the exchange rate, the rupee has recorded a depreciation of 33.0 per cent against the US dollar thus far in 2022 (by 08 April 2022). The gross official reserves as of end March 2022 were provisionally estimated at US dollars 1.9 billion. Nevertheless, the excessive depreciation of the exchange rate amidst the lacklustre performance in foreign exchange inflows warrants certain policy actions.

 

Inflation  is  on  the  rise  due  to  both  supply  side  factors  and  mounting  aggregate  demand pressures

Headline inflation continued to accelerate driven by the supply side disruptions, while underlying demand pressures in the economy remain intact as reflected by the continued acceleration in core inflation. The emerging developments indicate that inflationary pressures would continue in the near term driven by elevated prices of global commodities and their direct and second round impact on domestic prices, in addition to the price impact that could arise with the depreciation of the Sri Lanka rupee requiring the Central Bank to take further proactive measures.

 

Market interest rates are adjusting upwards gradually

Market interest rates have been gradually adjusting upwards in response to tight monetary policy measures adopted thus far. However, adjustments in deposit rates remain inadequate to attract deposits into the banking system from the excessive currency in circulation. Yields on government securities have also increased notably compared to other market rates given the higher government borrowing requirement  thus  creating anomalies in  the market  interest  rate  structure.  Although a slowdown in the growth of broad money (M2b) was observed due to the decline in net foreign assets (NFA) of the banking system, net domestic assets (NDA) of the banking system have increased significantly.

 

Adverse  developments  in  both  global  and  domestic  fronts  have  posed  challenges  to  the domestic economic performance

As per the GDP estimates published by the Department of Census and Statistics (DCS), the Sri Lankan economy grew by 1.8 per cent, year-on-year, in the last quarter of 2021. Accordingly, the Sri Lankan economy has recovered from the contraction of 3.6 per cent in 2020 and recorded a growth  of  3.7  per  cent  in  2021.  Growth  prospects  for  2022  are  affected  by  the  recent  adverse developments on the global front in terms of supply chain disruptions and rising commodity prices as well as on the domestic front, particularly interruptions to power and energy supply and other shortages.

 

Monetary and other policy measures are expected to further tighten monetary conditions

Considering  the  severity  of  the  external  shocks,  rising  inflationary  pressures  and  continued imbalances in the economy, the Monetary Board was of the view that a comprehensive set of policy measures, along with other initiatives that have an impact on the overall economy, is essential to safeguard stability on all fronts and to counter economic headwinds. Accordingly,  after carefully considering the current and expected macroeconomic developments both globally and domestically, the Monetary Board of the Central Bank of Sri Lanka, at its meeting held on 08 April 2022, decided to  increase  the  Standing  Deposit  Facility  Rate  (SDFR)  and  the  Standing  Lending  Facility  Rate (SLFR) of the Central Bank by 700 basis points to 13.50 per cent and 14.50 per cent, respectively, effective from the close of business on 08 April 2022. The Monetary Board also decided to remove caps  imposed  on  lending  interest  rates  applicable  to  credit  cards,  pre-arranged  temporary overdrafts, and pawning facilities to facilitate the effective transmission of the policy adjustment. The Board noted that such policy and regulatory actions, upon quick transmission, would raise the cost of funds, thereby containing the expansion of money and credit; inducing the return of excessive currency  in  circulation  to  the  banking  system;  eliminating  interest  rate  anomalies;  easing  the pressure on the exchange rate; and containing the build-up of demand pressures in the economy. Financial institutions are urged to raise interest rates on their products, particularly deposit rates for the benefit of the depositors. In line with the current monetary policy stance, the Central Bank would also continue with the ongoing programme to reduce its holdings of Treasury bills and hence unwind monetary stimulus.

The Central Bank and the Government have already begun working closely with the International Monetary  Fund  (IMF)  to  formulate  a  sustainable  solution  to  overcome  the  macroeconomic challenges faced by the country at present. Negotiations to obtain bridging financing have already commenced  with  interested  counterparties.  The  Monetary  Board  firmly  believes  that  the  policy measures adopted thus far by the Central Bank and further measures that are expected to be taken by the Government and the Central Bank would reinforce greater stability in prices as well as in the external,  monetary,  and  financial  sectors,  while  restoring  the  confidence  of  stakeholders  of  the economy on the way forward.

 

 

Monetary Policy Decision:      Policy rates increased and SRR unchanged

Standing Deposit Facility Rate (SDFR)                                          13.50%

Standing Lending Facility Rate (SLFR)                                         14.50%

Bank Rate (automatically adjusted with SLFR)                           17.50%

Statutory Reserve Ratio (SRR)                                                        4.00%

 

INFORMATION NOTE:

The release of the next regular statement on monetary policy will be on 19 May 2022.

 

 

 

 

 

 

 

 




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