ECONOMYNEXT – Sri Lanka’s central bank has cut its ‘single policy rate’ by 25 basis points to 7.75 percent, saying it will help push up inflation to its 5 percent target.
The central bank has allowed itself to push up inflation up to 7 percent without any questions being asked by the parliament under provisions of its monetary law.
“The Board is of the view that this measured easing of monetary policy stance will support steering inflation towards the target of 5 perent, amidst global uncertainties and current subdued inflationary pressures.
“Deflationary conditions have begun to ease since March 2025, as predicted.”
Sri Lanka central bank has created less than 1 percent inflation over 31 months since external monetary stability was restored in September 2022.
The so-called ‘deflation’ was a statistical artefact of calculating 12-month inflation.
READ MORE: Sri Lanka inflation up 0.89-pct over 31 months, 12-m down
The central bank however has drawn praise for operating East Asia style deflationary policy until the third quarter of 2024, preventing energy and food price rises and contributing to social unrest unlike the way it did after the end of a civil war, through ‘monetary accommodation’ and targeting ‘potential output.’ (Sri Lanka central bank ‘exceptionally great’ in achieving deflation: legislator)
At current rates forward-looking real interest rates are only 75 basis points above its highest inflation it has lobbied to to allow the parliament to give.
However analysts had pointed out that unlike in the last quarter of 2024, when large volumes of money was printed to suppress the overnight interbank rates at 8.5 percent, amid credit conditions then prevailing, in the first quarter the the 8.0 percent mid-corridor no money was being printed to endangering external stability.
Rate was being held up by the psychological effect of what is called ‘signalling’ versus the brute force of printed money which is called ‘heavy lifting’ in modern inflationary central banking.
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Thought rates were slightly higher than credit demand (the central bank is able to buy dollars to create liquidity) it was not clear whether it can collect sufficient reserves to reduce domestic credit and repay debt and also meet a foreign reserves target.
“Continued net forex purchases by the Central Bank helped strengthen the official reserves amidst debt servicing and other forex outflows,” the monetary authority said.
Analysts have also warned that central banks before the 1920s, that did not have a centrally planned policy rate or indiscriminate open market operations, were able to act a banker to the Treasury and provide reserves, without a conflict (there was no ‘monetary policy’ as such) as the discount rates were directly tied to its external (or gold) reserves.
However it was not the case where a bank of issue decides its discount rate on other considerations such as statistics, rejecting economic principles and laws of nature, in particular the ‘price specie flow mechanism’ as applied to net foreign assets.
A note-issue bank has to necessarily run deflationary policy to repay its own debt.
It also has allow liquidity to fall if the Treasury ‘buys’ reserves from the agency using reserve money, which may push short term rates above its ‘single’ policy rate, to maintain external stability and prevent depreciation and social unrest.
The full statement is reproduced below:
The Monetary Policy Board decided to reduce the OPR by 25 bps to 7.75% at its meeting held yesterday, thereby easing monetary policy further.1 The Board arrived at this decision after carefully considering the developments both domestically and globally.
The Board is of the view that this measured easing of monetary policy stance will support steering inflation towards the target of 5%, amidst global uncertainties and current subdued inflationary pressures.
Deflationary conditions have begun to ease since March 2025, as predicted.
The latest projections show signs of a more gradual pickup in inflation in the near term than previously anticipated.
Accordingly, inflation is expected to turn positive in early third quarter of 2025 and gradually align with the target thereafter. Core inflation is also expected to increase gradually in the coming months from current low levels. Inflation expectations are also aligning with the inflation target.
Recent leading economic indicators reflect sustained progress in domestic economic activity. However, global uncertainties, which could have implications on Sri Lanka, have escalated from the time of the previous monetary policy review.
Meanwhile, most market interest rates have stabilised at lower levels. With the current policy easing, the Board expects further downward adjustments in lending rates. Credit flows to the private sector remain strong with key economic sectors benefitting from such expansion.
This credit expansion is expected to continue throughout the year, with further support from the latest easing.
Thus far during the year, the external sector performance remains robust. This is supported by inflows in the form of earnings from tourism and workers’ remittances, despite the widening of the trade deficit.
Continued net forex purchases by the Central Bank helped strengthen the official reserves amidst debt servicing and other forex outflows. The Sri Lanka rupee recorded some depreciation against the US dollar so far during the year, following two years of annual appreciation against major currencies.
The Board will carefully assess incoming data on the domestic and global fronts and take measures, as appropriate, to ensure that inflation stabilises around the target of 5%, while supporting the economy to reach its potential.
The release of the next regular statement on the monetary policy review will be on 23 July 2025. (Colombo/May22/2025)
