CB expected to hold rates amid signs of easing price pressures

• Monetary Board to meet on Wednesday; 7th monetary policy review for this year to be announced Thursday morning 
• Prices in economy broadly appeared to have peaked by last month
• CB has delivered a cumulative 950bps policy rate hike so far this year to tame inflation 
• IMF staff deal, commencement of debt restructuring talks rekindle hope for economic recovery 
• Treasury bill yields have also somewhat eased from their recent highs while tight monetary policy has crippled credit markets

The Central Bank is widely expected to hold its key rates steady this week, when the monetary board meets tomorrow (Wednesday) to review its monetary policy for the seventh time of the year, after delivering a cumulative 950-basis-point hike through July, in a bid to tame roaring inflation, which hit almost 70 percent in September. 

Despite the fact that inflation has continued to rise since the last policy rate hike in July, the prices broadly appeared to have peaked by last month while the country has also made some progress in taking a slew of pre-emptive actions to fix its unsustainable budget deficit through multiple tax hikes, introducing of new taxes and expenditure restructuring. 

The government was also able to strike a staff-level agreement with the International Monetary Fund (IMF) for a US $ 2.9 billion for a four-year economic stabilisation package on August 31, amid early commitments shown towards tough reforms such as cost-reflective pricing of electricity, fuel and water and reforming the loss-making state-owned enterprises. 

Following the staff deal with the IMF, the authorities two weeks ago invited all official and private creditors of Sri Lanka to expedite the restructuring of the country’s foreign debt, a process they expect to end in December. Both events rekindled hopes for economic recovery.

Meanwhile, the yields in the last few Treasury bill auctions have also eased somewhat from their recent highs, largely caused by the heightened concerns of a possible restructuring of rupee debt. 

 Foreigners have also shown renewed interest in Sri Lankan equities and bonds, as they have begun accumulating billions of rupees worth of investments in both markets. 

At the same time, the bone-crushingly tight monetary policy has killed private credit markets while the money supply has also fallen sharply. The private credit growth fell for the fourth month in a row in August while money supply measured by broad money or M2b growth eased to 14 percent in the year to August 2022, from 21 percent a year ago. Further, the monetary financing of the budget deficit has also stopped to a greater extent in recent times, as the stock of bills and bonds held by the Central Bank on behalf of the government hasn’t changed massively since July through the end of September, which is at Rs.2,320 billion. Also, the acute shortages of commodities prevailed through July have abated now and the supplies of fuel, medicines and other essentials are now available, even with limited quantities and at sky-high prices.  

The Central Bank in April embarked on a series of demand destruction policies from rate rises to restrictions on imports to bring the prices and imports under control, of which the results are gradually coming through.