Sri Lanka’s falling external deficits should allow the central bank to review its tight monetary and credit policies towards the end of the year, Governor Ajith Nivard Cabraal told Reuters yesterday.

The Central Bank has raised key policy rates twice since February, allowed a flexible exchange rate, and told banks to limit credit growth in order to tame the worryingly high deficits.

While the deficits were coming down, Cabraal said the central bank needed a little longer to see the results of its strategy before deciding whether to relax the tight policies in order to put back momentum in the economy. He expected to be able to take a clearer view towards the end of the year.

“By that time we will be in a better position to understand ... the new equilibrium we are looking at,” he said in an interview. “So based on that equilibrium we can turn on the engine.”

The bank has held rates steady since April, while economic growth slumped to a 2 1/2 year low in the April-June quarter. For now, Cabraal said, the bank could leave policy unchanged.

“It is very clearly seen with the trade deficit coming down, balanceof-payments moving into the black... that we don’t need to make any further adjustments as far as interest rates are concerned,” he said. “So it’s not a question of easing it or tightening it any further.”

 Sri Lanka posted a record $9.7 billion trade deficit and a $4.6 billion current account deficit in 2011, as a combination of a heavily defended rupee and a credit boom fuelled by low interest rates led to soaring imports of consumer and capital goods.

Since November, mainly due to the flexible exchange rate policy, the rupee has depreciated by more than 16 percent, driving up the cost of imports.

Turning to foreign direct investment, Cabraal warned that the government may have to revise down its $2 billion target for this year due to companies delaying investments already approved by the government.

(Source : Reuters)