Central Bank blames rate hike on skyrocketing inflation

The Central Bank plucked up the courage to raise benchmark interest rates up by 50 basis points with immediate effect, putting an end to Sri Lanka’s 12 month honeymoon of low interest rates. The Central Bank plucked up the courage to raise benchmark interest rates up by 50 basis points with immediate effect, putting an end to Sri Lanka’s 12 month honeymoon of low interest rates. The repurchase rate was raised to 7.5 percent and the reverse repo rate hiked to 9.0 percent, the bank said ahead of a planned Friday announcement.

The announcement took markets by surprise, as the bank had continuously skirted the issue through low treasury yields and a few donor funds.

Analysts were expecting the bank to raise rates by 25-30 basis points from early next year, if oil prices don’t cool off and inflationary pressures continue.

The bank’s monetary board’s – which makes a call on benchmark rates – lackadaisical attitude deliberately kept rates steady for a year, ignoring warning signs of galloping inflation and negative real rates, have always been the subject of intense debate in the market.

Inflation, as measured by the Colombo Consumer Price Index, has shot up to 14.4 percent in September from 1.4 percent last year.

The dreaded word ‘inflation’ figured prominently, when the bank gave out its official reason for raising rates.

“The acceleration in the monetary aggregates so far in the year indicates the possibility of the onset of demand-fuelled pressure on inflation. The Central Bank is of the view that a tightening of monetary policy is therefore, required to curb the build up of inflationary pressure and inflationary expectations in the economy,” the bank said in a statement on Wed., following the monthly monetary policy review meeting.

The rupee has also considerably weakened, falling by 7.0 percent as at end Oct. The bank has stepped into the market on numerous occasions to stabilize the currency, but at the expense of hard earned foreign exchange reserves.

“Gross official reserves declined from US$ 2,069 mn (about 3.3.months of imports) in August to US$ 1,943 mn (about 3.1 months of imports) in September 2004.”

Despite a 11 percent growth in worker remittances for the nine months ending Sept., inflows to the capital and financial accounts barely cover the current account deficit.

For the nine months ended Sept., the balance of payments have widened to US$ 245 mn. Last year, the country boasted of a US$ 250 mn balance of payment surplus. The BOP shortfall, the first in four years, has been blamed on sky high crude oil prices, which will cost the Exchequer an extra US$ 100 mn this year.

The repo and reverse repo rates were last trimmed in October 2003, when they were cut by 50 basis points and 100 basis points, respectively.

The next regular statement on monetary policy will come out on December 15.

-LBO Newsdesk: LBOEmail@vanguardlanka.com