The Monetary Board of the Central Bank of Sri Lanka, at its meeting held on 24 January 2023, decided to maintain the Standing Deposit Facility Rate (SDFR) and the Standing Lending Facility Rate (SLFR) of the Central Bank at their current levels of 14.50 per cent and 15.50 per cent, respectively. The Board, having noted the recent and expected developments and projections on the domestic and global macroeconomic fronts, was of the view that the maintenance of the prevailing tight monetary policy stance is imperative to ensure that monetary conditions remain sufficiently tight to rein in inflationary pressures. Such tight monetary conditions, together with the tight fiscal policy, are expected to adjust inflation expectations downward, enabling the Central Bank to bring inflation rates towards the desired levels by end 2023, thereby restoring economic and price stability over the medium term.
Inflation continued to decline as envisaged in recent months and is projected to follow a faster disinflation path
Year-on-year headline and core inflation, based on both the Colombo Consumer Price Index (CCPI) and the National Consumer Price Index (NCPI), continued to decelerate in December 2022 for the third consecutive month, as expected. The downward adjustment in inflation rates is expected to continue through 2023, supported by subdued aggregate demand resulting from tight monetary and fiscal policies, expected improvements in domestic supply conditions, and the passthrough of easing global commodity prices to domestic prices, along with the favourable statistical base effect.
Domestic economic activity is expected to recover towards the latter part of 2023, compared to the large contraction in 2022
As per the GDP estimates published by the Department of Census and Statistics (DCS), the real economy is estimated to have contracted by 7.1 per cent in the nine months ending September 2022, on a year-on-year basis. With tighter monetary and fiscal policies in place, along with disruptions to domestic supply conditions, real activity in the final quarter of 2022 is also expected to have remained subdued. The economy is expected to make a gradual recovery during the year supported by the expected improvements in domestic supply conditions, underpinned by the timely implementation of corrective policy measures. Meanwhile, the anticipated improvements in foreign exchange flows and the resultant enhancement in business and investor sentiment are expected to reinforce the expected recovery in the period ahead.
Excessive market interest rates have begun to adjust downward and are expected to ease further in the period ahead
Early signs of a gradual easing of excessive market interest rates have been observed recently in response to the administrative measures adopted by the Central Bank, along with the improvements in domestic money market liquidity and overall sentiments in the domestic markets. Recent measures adopted by the Central Bank to reduce the overreliance of licensed commercial banks on the standing facilities of the Central Bank and the concurrent conduct of open market operations helped improve liquidity in the domestic money market. This prompted activity in the interbank money market. Improved liquidity conditions, along with improved investor sentiment on the anticipation of “financing assurances” from official creditors, led to a notable moderation in the yields on government securities recently, reflecting the easing of the high risk premia attached to government securities. Meanwhile, the market deposit rates have also shown a notable moderation, benefiting from improved liquidity conditions. These developments are expected to pave the way for an easing of excessive market interest rates in the period ahead. Nevertheless, outstanding credit extended to the private sector by commercial banks continued to contract in response to the tight monetary conditions and the moderation in economic activity. Monetary expansion also moderated from peak levels, albeit at a slower pace.
The external sector remains resilient despite heightened challenges, and the outlook remains positive with the expected improvements in relation to “financing assurances” from creditors
The merchandise trade deficit is estimated to have contracted significantly in 2022, compared to recent years, owing to an improvement in export earnings and a substantial compression of import expenditure on account of policy measures taken to curtail non urgent imports and foreign exchange liquidity constraints. The gradual improvement in workers’ remittances, together with the revitalisation of tourism, helped improve the external current account balance in recent months while easing excessive pressures in the domestic foreign exchange market. As a result, the exchange rate has remained relatively stable, and recorded a marginal appreciation against the US dollar, thus far in 2023. Gross official reserves were estimated at US dollars 1.9 billion as of end 2022, including the swap facility from the People’s Bank of China, equivalent to around US dollars 1.4 billion. The envisaged finalisation of the IMF-EFF arrangement in the period ahead and the resultant developments that follow, along with the improvements in the external current account, are expected to enhance the external sector outlook.
Policy interest rates are maintained at current levels
In consideration of the current and expected developments, both domestic and global, as indicated above, the Monetary Board of the Central Bank of Sri Lanka, at its meeting held on 24 January 2023, decided to maintain the Standing Deposit Facility Rate (SDFR) and the Standing Lending Facility Rate (SLFR) of the Central Bank at their current levels of 14.50 per cent and 15.50 per cent, respectively. The Board was of the view that the current monetary policy stance is appropriate to ensure that underlying monetary conditions in the economy remain sufficiently contained to drive inflation along the envisaged disinflation path. While some downward adjustment in market interest rates has been observed lately, the Monetary Board is of the view that there is sufficient space for excessive market interest rates, including lending interest rates to Small and Medium Sized Enterprises (SMEs), to adjust downwards considering the recent improvements in domestic money market conditions and sentiments along with the moderation in the yields on government securities. However, the Board was also of the view that the anticipated further decline in the yields on government securities due to the narrowing of risk premia is unlikely to result in a significant improvement in underlying monetary conditions. The Central Bank will continue to closely monitor monetary conditions in the period ahead and will remain prepared to take swift and proactive measures, as appropriate.