Sri Lanka Sees Room to Cut Interest Rates

07th October 2009, www.bloomberg.com

Sri Lanka’s central bank has room to cut interest rates should inflation remain “persistently low” as it seeks to support the island’s economic recovery after a 26-year civil war, Governor Nivard Cabraal said.

The economy may grow as much as 6 percent next year after expanding about 3.5 percent in 2009, Cabraal said yesterday in an interview in Istanbul, where he is attending the annual meetings of the World Bank and the International Monetary Fund.

The South Asian nation’s benchmark stock index, Asia’s best performer this year, closed at a record high yesterday on optimism that lower interest rates will boost earnings as the economy grows. Borrowing costs are already at a three-year low.

“If we see persistently low inflation, then we’ll see some reason to make some adjustments in the months ahead,” Cabraal said. “We don’t need to do any changes right now because we are on the right track. We don’t need to have a knee- jerk reaction.”

The central bank on Sept. 11 lowered the reverse repurchase rate to 10.5 percent from 11 percent, and cut the repurchase rate to 8 percent from 8.5 percent. Commercial banks are increasing lending at a “reasonable” rate as borrowing costs fall, Cabraal said.

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.

“Naturally, we are worried about a possible resurgence in inflation but at the same time our demand management has been so good that to some extent, it offsets the possible increases that may arise in the supply side,” he said. “We are confident we will be able to manage that.”

Civil War

Sri Lanka’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. Output in the fisheries and agricultural industries will also show “strong growth,” Cabraal said.

Sri Lanka may resettle 100,000 ethnic Tamil civilians stranded in transit camps in the country’s north by the end of this year, Deputy Finance Minister Sarath Amunugama said in Istanbul yesterday.

There is little risk of asset bubbles forming in the economy even as funds pour into the country’s stock market and investment increases, the governor said. The Colombo All-Share Index rose as much as 1.9 percent to 3,156.37 yesterday, the highest-ever for the measure of 238 companies on the Colombo Stock Exchange.

“We are not too worried about asset bubbles because what is being taken up is the slack that has been around for a long time,” Cabraal said. “It hasn’t reached that stage as yet.”

To contact the reporters on this story: Shamim Adam in Istanbul at sadam2@bloomberg.net