Sri Lanka’s central bank has has raised interest rate at which overnight money is printed for banks by 100 basis points to 15.5 percent as the country was gripped by galloping inflation and depreciation.
“Having noted the higher than expected escalation of headline inflation recently and the increased persistence of high inflation in the period ahead, the Board was of the view that a further monetary policy tightening would be necessary to contain any build-up of adverse inflation expectations,” the central bank said in its June monetary policy review.
“In arriving at this decision, the Board weighed the impact of tighter monetary conditions on overall economic activity, including the micro, small, and medium scale businesses, and the financial sector performance, among others, against far reaching adverse consequences of any escalation of price pressures across all sectors of the economy in the near term.
“On balance, the Board was of the view that this policy adjustment would help guide inflation expectations to be anchored around the targeted level of headline inflation over the medium term, while curtailing any build-up of underlying demand pressures in the economy”.
The central bank urged the government to also reduce the deficit as quickly as possible to stop printing money.
“Faster implementation of the expected fiscal reforms aimed at strengthening government revenue mobilisation and expenditure rationalisation is needed to reinforce fiscal consolidation efforts, including the expected improvements in the financial position of state-owned business enterprises,” the central bank said.
“Such adjustment in fiscal sector performance would result in a decline in gross financing needs of the Government in the period ahead, and help scale down monetary financing at a faster pace.”
The central bank which also conducts Treasuries auctions allowed Treasury bill yields this week to stop 28 percent in a bid to avoid printing money.
Sri Lanka is experiencing high inflation after two years of money printed to keep rates down and boost growth (stimulus), and a failed float with a surrender requirement.
In June consumer prices in Colombo hit 54.6 percent as the rupee fell from 200 to 360 and forex shortages continue to persist due to the failed float.
According to a fan chart published by the central bank, inflation could peak around 75 percent, with a low probability of it going higher.
Download Monetary Policy Review Sri-Lanka-June-Monetary_Policy_Review
Private credit has started to slow and market rates have risen, the central bank said.
“..The growth of credit to the private sector, once adjusted for the impact of the depreciation of the Sri Lanka rupee against the US dollar, recorded signs of slowing in May 2022, year-on-year, while the expansion of broad money has been weighed down by the contraction in net foreign assets of the banking system,” the statment said.
“The elevated lending interest rates are expected to slow the expansion of money and credit aggregates in the period ahead…”
Sri Lanka has experienced rapid currency crises and monetary instability over the past 7 years with the adoption of highly discretionary flexible inflation targeting and a flexible exchange rate, which critics have likened to un-anchored monetary policy.