July 24, 2006 (Dow Jones)–The Central Bank of Sri Lanka raised the repurchase rate and the reverse repo rate by 12.5 points each over the weekend, the second consecutive hike this year, pushing both rates up to a three-year high in a bid to fight inflationary pressures and support the rupee. But analysts say the quantum of increase is insufficient and the central bank may need to lift rates by at least another 50 basis points before the year is out.
“Since inflation has been mostly a result of the demand pressure in the economy, the Monetary Board decided to further tighten the monetary policy to subdue the demand pressure,” the central bank said in a statement.
The hikes, which take effect Monday, came two days ahead of schedule. The bank was set to announce its monthly policy decision Monday.
“We expected a hike but this increase is not sharp enough. We expected at least a 25-basis point hike,” said a trader at a local bank who declined to be identified.
“We are definitely going to see further increases as domestic fuel prices could climb further on the back of rising world oil prices, stoking inflation,” said Geeth Balasuriya, analyst at HNB Stock Brokers.
The central bank increased the overnight repurchase rate to 9.125% and the reverse repo rate, the rate which the central bank pays other banks for short term funds, to 10.625% to contain inflationary pressures.
Last month, the bank raised both rates by 25 basis points.
Sri Lanka’s consumer price index rose 10.1% in the 12 months ended June compared with 9.4% in the year ended May, as food prices rose after recent fuel price hikes.
Costlier petroleum imports due to stubbornly high global oil prices have also hurt the rupee in recent weeks although central bank support for the currency has limited losses.
Still, the rupee is down nearly 2% against the U.S. dollar so far this year, with around half of the decline recorded in June.
The central bank said in a statement that its previous policy rate hikes and aggressive open market operations since November 2004 have stemmed high growth in Sri Lanka’s money supply.
But the growth in money supply still remains high, the central bank said, without giving details.
Nevertheless, the economy grew at a “healthy” rate of 8.1% in the first quarter of 2006, led by key sectors such as telecommunications, tourism and construction, the central bank said.
Last month, central bank Governor Ajith Nivard Cabraal said Sri Lanka can achieve its targeted 8% gross domestic product growth in 2006 despite challenges.
He said the two main challenges are the effect of high global oil prices and the country’s security situation, which has raised fears of a resumption of a full-scale civil war.
The statement said the economy has also benefited from continued growth in international trade due to sustained external and domestic demand.
Total exports in the first five months of 2006 grew by 5.8% on year while imports in the same period surged 21% on-year mainly due to expensive petroleum imports.
However, the widened trade deficit was offset by increased foreign currency inflows through private remittances which grew 26% in the January-June period, said the statement.
As a result, the country’s balance of payments has recorded a surplus of $207 million in the first half, it said.
The central bank recently revised its year-end inflation forecast to 11% from 8%-9% earlier due to the increase in fuel prices.
When inflation surged last year due to higher global oil prices, the central bank aggressively tightened its monetary policy, adding 125 basis points to its interest rates through the year.
Despite satisfactory economic growth, “the rise in fuel prices remains a concern in overall macro-economic management,” said the central bank statement. Analysts say after two consecutive hikes, the bank may stay pat on rates when it next meets on Aug. 16 and increase rates later in the year.