Sri Lanka’s real interest rates outlook poised to turn positive

• Faster than expected disinflation could soon flip real rates from negative to positive despite policy rate cuts 

Sri Lanka’s real interest rates, which have long been negative, are poised to turn positive with the more noticeable decline in inflation than the decline in interest rates in response to the recent policy rate cuts and the absence of risk premia following the domestic debt restructuring announced earlier last month. 
July inflation was recorded at mid-single digit level of 6.3 percent from a year ago, much earlier than many would have expected as a result of significantly higher base effects from the previous year and a reduction in commodity prices amidst weak demand conditions.

“ ….given the faster than expected disinflation path, real interest rates are less accommodative, while forward looking are largely positive,” the Central Bank said in their maiden Monetary Policy report which was released on Monday. 
Real interest rate is the nominal rate minus the inflation rate in the economy. A negative real rate destroys the value of money people carry or save in banks. 
At its peak in September last year, Sri Lankans were losing nearly 60 percent of the return they received for the deposits they held in the banks as runaway inflation was eroding the real value of their money. 

Since then, the negative real rates were slowly narrowing as the inflation was easing. By end of May 2023, just prior to the first rate cut was announced, the real rates were within 0-10 percent range after the two back-to-back inflation reports that showed significant declines. 
The similarly softer than expected inflation prints which followed in the next two months appeared to have flipped the real rates into positive territory despite the two policy rate cuts that came in June and July.

Real rates first flipped to negative territory around September 2021 when the entire world was going through a price spiral in response to pandemic related economic anomalies, which prompted central banks to crack down on demand.
The softer than expected inflation reading in July could provide further ammunition to the Monetary Board to double down on their rate cut path to make money available at affordable levels to businesses and individuals to support growth. 
The Central Bank has warned that it would be forced to implement administrative action against banks if they do not pass on the benefits of policy rate cuts and remove risk premia associated with debt restructuring in a timely manner.