Sri Lanka Benchmark Interest Rate Unchanged to Boost Growth

13th October 2009, www.bloomberg.com

Sri Lanka’s central bank kept its benchmark interest rate unchanged at a three-year low to support the island’s economic recovery after a 26-year civil war.

The Central Bank of Sri Lanka left the reverse repurchase rate at 10.5 percent, according to a statement on the Colombo- based bank’s Web site today. The repurchase rate was also maintained at 8 percent.

Governor Nivard Cabraal said last week the central bank has room to cut interest rates if inflation remains “persistently low.” Sri Lanka’s benchmark stock index, Asia’s best performer this year, has risen to unprecedented levels on optimism that lower borrowing costs will boost earnings as the economy grows.

“With inflation low, the central bank can afford to cut rates,” said Danushka Samarasinghe, research manager at Asia Securities Ltd. in Colombo. “Their priority is growth and for credit demand to kick in.”

Consumer prices will probably climb between 3 percent and 5 percent this year, and inflation may accelerate to between 5 percent and 6 percent in 2010, Cabraal said Oct. 6.

The island’s inflation is expected to be at “subdued levels in the approaching months,” the central bank said today.

Consumer prices in the capital, Colombo, rose 0.7 percent in September from a year earlier after gaining 0.9 percent in August. That’s the weakest pace in at least five years.

War Damage

Sri Lanka’s $41 billion economy may grow as much as 6 percent next year after expanding about 3.5 percent in 2009, Cabraal said.

The island’s growth is expected to be driven by domestic demand including infrastructure development and construction activity as the end of the civil war spurs rebuilding in areas formerly controlled by the separatist Liberation Tigers of Tamil Eelam, he said.

Sri Lanka’s borrowing costs are expected to ease further and boost credit demand by private firms amid an “improved outlook for economic activity,” according to today’s central bank statement.

The country’s benchmark Colombo All-Share Index rose 0.3 percent to 3,139.73 at the close today, the highest-ever for the measure of 238 companies.

Equity purchases have accelerated as returns from government bonds ease with declining interest rates, Samarasinghe said. “There is a significant shift in funds from fixed income to the stock market,” he said.

Bank Lending

The central bank on Sept. 11 lowered the reverse repurchase rate from 11 percent, and cut the repurchase rate from 8.5 percent.

Commercial banks are increasing lending at a “reasonable” rate as borrowing costs fall, Cabraal said Oct. 6.

The International Monetary Fund said on Sept. 22 it’s “cautiously positive” on the island nation’s prospects as it reviews the economy for the release of a second payment in its $2.6 billion loan package to Sri Lanka.

In return for the IMF loan, Sri Lanka agreed to reduce its budget deficit to 5 percent of gross domestic product by 2011, from 7 percent this year, 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 said on Oct. 8 that it had met its key IMF targets as of the end of September.

The outlook on Sri Lanka’s long-term foreign and local currency issuer default ratings was revised to stable from negative at Fitch Ratings on Oct. 9. Fitch affirmed the country at B+.

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