ECONOMYNEXT – Sri Lanka cut rates by 25 basis points to due to lower than projected inflation and expected lower external demand from geopolitical uncertainties, Central Bank Governor Nandalal Weerasinghe said.
Sri Lanka’s central bank lowered its lending window rate to 8.25 percent and the enforceable deposit facility to 7.25 percent.
It so-called overnight policy rate which has been held up by ‘signalling’ in recent weeks, was lowered to 7.75 percent.
“Inflation is moving at a lower path than we projected in the last review,” Governor Weerasinghe told reporters explaining the rational for the rate cut.
“The projection is moving below the lower the path but reaching towards target range of 5 percent.
“The second point in terms of aggregate demand, compared to the last review we all know because of the global uncertainties some to geopolitical issues, the IMF has revised the global outlook.
“That means from the overall aggregated demand point of view the external component will be lower than what we expected the last time.”
The US has slapped a 44 percent tax on Sri Lanka’s exports to the country, though only 10 percent is applied for three months, as discussions continue.
The monetary policy decision has been made expecting the ‘status quo’ to continue, Governor Weerasinghe said.
“Here is some space now created to ease monetary policy this time,” Governor Weerasinghe said.
“In two month’s time the we will review it again and see and whether our projections are in outlook and whether there is some more space.”
There is rising concern that that the latest rate is similar to the rate cuts in April 2015, and April 2018, which were made as credit recovered, precipitating a fresh currency crisis.
At both instances however, the central bank was already printing money and releasing liquidity as private credit picked up from the previous external crisis triggered by rate cuts.
The central bank was releasing liquidity by terminating dollar rupee swaps from the last quarter of 2014 when the rate cuts for the 2015/16 crisis was made.
In 2018, money was printed mostly through rupee open market operations to enforce the April rate cut, to trigger the crisis.
Unlike in 2015 and 2018 and 2020 the central bank does not have to immediately print money to enforce the rate cut.
Sri Lanka runs into currency crises frequently as rates are cut on criteria unrelated to balance of payments, analysts have pointed out.
These include the flexible inflation targeting after the end of a civil war (trying to target inflation without a clean float) and trying to target money supply without a floating rate in the 1980s both of which led aggravated conflicts between domestic and external anchors, currency depreciation, social and political unrest.
At the current moment the central bank is not printing money and the ‘signalled’ overnight policy at 8.0 percent rate was higher than the floor rate of 7.50 percent, and all excess liquidity was from dollar purchases.
The central bank is able to purchase dollars creating new money, because not all inflows which are saved, is invested to generate imports, at the rate then prevailing.
Credit to government in particular is easing with budget deficits narrowing.
However, on the flip side, bank deposit and lending rate had started to edge up, indicating an economic and credit recovery, and has been leading indicator of what is happening in the overall economy in the past, unlike 12-month inflation which is a lagging indicator and statistical projections which are frequently wrong.
In the last quarter of 2024 also the central bank injected large volumes of money to target a mid-corridor rate, which analysts point out, undermining price signals and the workings of the interbank market.
Sri Lanka has to collect reserves not only to repay central bank’s debt and but also government debt.
Sri Lanka’s central bank in any case has had a flawed operating framework for about 73 years, requiring exchange controls and import controls to be imposed on the general public and businesses, undermining overall economic freedoms.
The forex shortages and controls have also led to protectionist rent-seeking, import substitution and self-sufficiency doctrines triggering high food prices in particular. (Colombo/May23/2025)
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