July 3, 2006 (LBO) – Sri Lanka does not need to raise interest rates despite galloping inflation and negative real interest rates, the island’s newly appointed Central Bank governor said Tuesday. The country’s annual inflation rate shot up to 17.7 percent, data showed last Friday, underlining the need for a rate hike.
Sri Lanka’s treasury bill rates are just over 10.0 percent, and Central Bank’s policy rate, at which it drains liquidity from the system is only 9.00 percent.
“I think it’s a bit too early to make a change,” Central Bank’s new governor Nivard Cabraal said. “I need to have discussions with bank staff on interest policy before commenting further.”
In June inflation rose 3.9 percent, on the back of a 5.4 percent and 2.7 percent rise in April and May, driving twelve month inflation from 6.4 per cent in March to the June figure of 17.7 percent.
Between February and June the Central Bank printed more than 20 billion rupees to finance the rising cost of subsidies, public sector salaries and military expenditure.
In addition to pushing demand pressure up, analysts say the printing binge has also put pressure on the balance of payments.
The government also jacked up fuel prices in April, which, while contributing to a one-off rise in inflation, would reduce the need for more money printing in the future.
Sri Lanka’s 24 billion dollar economy is a net oil importer, but the government direct massive resources, including printed money, to keep fuel prices low.
After a five-month lag, the bank raised policy rates by 0.25 percent in June, following sharp rise central bank credit to government.
Market analysts who expected the central bank to keep rates low and continue to print money were taken by surprise when the reverse repo rate moved up to 9.00 percent in June, while the reverse repurchase rate changed by the same amount to 10.50 percent.