Central Bank slashes rates to revive economy

From left: CB Deputy Governor S. R. Attygalle, CB Governor Dr. Indrajit Coomaraswamy and CB Senior Deputy Governor. Dr. P. Nandalal Weerasinghe
Pic by Waruna Wanniarachchi

• Cuts policy rates by 50 basis points
• CB Governor says noteworthy current negative output gap led to the rate cute
• According to CB, monetary policy relaxation was needed to lessen Easter attack impact

In a surprise move, the Central Bank cut policy rates by 50 basis points aiming to further support the revival of the economy despite, the potential fiscal slippages ahead of the election cycle. 

Accordingly, the Central Bank’s Monetary Board at its meeting held on Thursday decided to reduce the Standing Deposit Facility Rate (SDFR) and the Standing Lending Facility Rate (SLFR) of the Central Bank by 50 basis points to 7.00 percent and 8.00 percent respectively.

The CB Governor, Dr. Indrajit Coomaraswamy said the significant current negative output gap was the key reason for the policy rate cut. The CB has identified Sri Lanka’s potential growth rate to be 5 percent. However, the economy is projected to grow at 3.1 percent well below the potential growth rate.

Sri Lanka’s private sector credit growth continues to decelerate to 7.7 percent Year-on-Year (YoY) compared to 8.7 percent YoY growth during the previous month, which was also the lowest growth rate witnessed since December 2014. 

The private sector credit also declined, in absolute terms, by a marginal Rs 1.2 billion in July after a significant increase of Rs 63.2 billion in June. 
The cumulative increase of private sector credit stood at Rs 42.5 billion during first seven months of the year. 

“The deceleration in credit extended to the private sector caused a slowdown in the growth of overall monetary aggregates during the period,” the CB stated.

In spite of the reduction of policy interest rates by 50 basis points in May 2019, the CB pointed out that market lending rates had not come down sufficiently to support the productive economic sectors.

Therefore, the CB viewed that further relaxation was monetary policy was necessary to support the economy, in particular, considering the economic impacts of Easter Sunday attacks. 
“Supported by this decision, the Central Bank expects all market lending rates to reduce in line with the reduction already observed in deposit interest rates,” the CB stated. 

CB noted the current monetary policy has already been accommodative with two SRR reductions totalling 2.50 percentage points and two downward adjustments to policy interest rates, which have resulted in the lowering of the policy rate corridor from 8- 9 percent to 7- 8 percent. 

The government revenue has already taken a hit from Easter Sunday attacks, expanding the fiscal deficit above this year’s targets.

However, the CB said that the current output gap outweighed the concerns over potential fiscal slippages. 

Further, the Governor noted that the external sector remains resilient, supported by an improved trade balance. 

However, the CB hinted that the further relaxation of monetary policy would be unlikely for the remainder of the year as the fiscal performance will be crucial in deciding the future trajectory of the monetary policy.

“The Monetary Board intends to review the impact of these measures as well as the fiscal performance and global developments, prior to deciding upon the future trajectory of monetary policy going forward,” the CB stated.