Sri Lanka on path to cut interest rates later this year

Mar. 24 (LBO) — Sri Lanka is likely to cut interest rates later this year, in a backdrop of declining inflation, a top bureaucrat who plays a key role in the country’s fiscal and monetary policies said Thursday. “There has been a consecutive drop in inflation over the past few months, which leaves room for changes in interest rates later this year,” Treasury Secretary P B Jayasundara told businessmen.

Jayasundera is also an influential member of the rate-setting monetary board of the Central Bank of Sri Lanka.

Inflation in this tropical island of 19.5 million people, was fuelled by expansionary fiscal policy and loose monetary policy in late 2004.

Prices stabilized in 2005 as the Central Bank reduced its inflation-causing credit to the government.

In January country-wide Sri Lanka Consumer Index fell to 3.2 percent on a year-on-year basis, while in February, the Colombo Consumer Price Index fell to 7.1 percent.

The annual averages (12-month moving average) of the country-wide index, which shows the long-direction of inflation, also fell below double digits to 9.4 percent in January.

The Central Bank last hiked rates by 25 basis points in December, and left interest rates unchanged in March, citing declining inflation.

The overnight repurchase rate is now at 8.75 percent and the reverse repurchase rate is at 10.25 percent.

Private sector credit is growing, and improving capital flows are driving reserve money growth.

But Jayasundera says a change may be considered in mid-2006.

“We maintained a tight monetary policy at that level in order to give a signal that inflation should continue to decline. The inflation rate for March should be much lower than February, which leaves room to relax monetary policy,” he said.

Sri Lanka’s fiscal deficit is expected to top 9.1 percent of gross domestic product (up from 8.5 percent in 2005) this year.

Jayasundara says domestic debt markets will not be pressed in to finance the deficit as the government has lined up substantial foreign financing.

“We have fairly large scale projects lined up to build roads, highways and power projects with substantial foreign investments. These projects will start this year, like the coal power plant with Chinese assistance,” he said.

-Mel Gunasekera: mel@vanguardlk.com