Sri Lanka hikes interest rates by 25 basis points to curb inflation

June 16, 2006 (LBO) – Sri Lanka’s Central Bank unexpectedly raised key interest rates by 25 basis points after a five month lag Friday, in a bid to curb inflation amidst soaring global oil prices. The next regular statement on monetary policy is scheduled for Friday July 14.

Please click here to read Central Bank’s
monetary policy statement for June

The Central Bank’s repurchase rate goes up 25 basis points to 9.00 percent, while the reverse repurchase rate changes by the same amount to 10.50 percent.

The repurchase rate is the return on cash deposited by commercial banks with the central bank and the reverse repurchase rate is the cost of borrowing from the Central Bank.

Investors were surprised by the announcement; though the writing was on the wall that the bank should hike rates after inflation in May hit 13.2 percent in the backdrop of galloping prices of crude oil, wheat and sugar.

“Continued expansion in economic activity, higher domestic demand and cost-push factors associated with the adjustments in the fuel prices led to an increase in the consumer prices in April and May 2006,” the bank said in its statement.

Inflation is also expected to rise further, after the government hiked fuel prices by 5-percent last weekend and announced a halt in future fuel subsidies.

The bank gave the government full marks for revising retail fuel prices and said that the adjustment would help ease the burden on the exchequer.

“It is necessary that all Sri Lankans respond positively by promoting the efficient use of energy as well as by promoting alternative non-fuel based energy sources, taking a longer-term view.”

However, money supply growth remains high, fueled by credit expansion and improving foreign reserves.

Broad money, which peaked at 21.5 percent in October 2005, as a result of the higher expansion in credit to the private and public sectors, “has been rising at around 20.0 percent.”

Reserve money has also grown by 18.0 percent in May, which is “above the targeted path.”

“This situation calls for the adoption of appropriate policy measures from both monetary and fiscal fronts to contain inflationary pressures.”