Central Bank to Cut Interest Rates as Sri Lanka’s Inflation Slowed

31st August 2009, www.bloomberg.com

Sri Lanka’s inflation slowed in August, giving the central bank room to cut interest rates to stoke an economic revival after the end of the island’s three- decade civil war.

Consumer prices in the capital, Colombo, rose 0.9 percent from a year earlier after gaining 1.1 percent in July, the statistics agency said on its Web site today.

Central Bank Governor Nivard Cabraal, who predicts 2009 inflation at 5 percent, on Aug. 18 said there was still room to cut interest rates after three reductions earlier this year. The South Asian island’s $41 billion economy is on the “right track” and will strengthen in coming months, Cabraal said.

“It is important for borrowing costs to fall further for investment to pick up and the economy to take off,” said Danushka Samarasinghe, research manager at Asia Securities Ltd. in Colombo. “The central bank will look for further easing.”

The Central Bank of Sri Lanka on Aug. 18 kept interest rates at a three-year low, holding the reverse repurchase rate at 11 percent for a second straight month and maintaining the repurchase rate at 8.5 percent.

Cabraal last month said there was “space for interest rates to come down further,” helping the government reduce the budget deficit in accordance with a $2.6 billion International Monetary Fundloan agreement.

The central bank wants lenders to cut borrowing costs before it lowers its key rates further, Cabraal said Aug. 18.

The IMF’s aid package and improved investor confidence with the end of the civil war have helped attract foreign flows and eased local borrowing costs, the central bank said July 23.

Budget Deficit

In return for the IMF loan, Sri Lanka has agreed to reduce its budget deficit to 5 percent of gross domestic product by 2011 and maintain flexibility in the exchange rate in order to build foreign reserves to cover 3 1/2 months of imports and bolster the economy.

The central bank last month raised its 2009 growth forecast to as much as 4.5 percent from an earlier estimate of 2.5 percent, citing increased investments and reconstruction projects in the island’s north and east after the government in May defeated the separatist Tamil Tiger rebels.

The IMF expects Sri Lanka’s economy to grow more than 3 percent this year and accelerate in 2010.

Inflation is expected to rise moderately during the second half of the year, even as it remains at single-digit levels, the central bank said Aug. 18.

The central bank has maintained a “cautious” monetary policy “to be sure inflationary pressure is finally over,” Cabraal said Aug. 18.

The central bank has this year reduced the repurchase rate by 2 percentage points and lowered the reverse repurchase rate from 12 percent.

To contact the reporter on this story: Anusha Ondaatjie in Colombo at anushao@bloomberg.net.