Sri Lanka cuts lending rate, but maintains deposit rate

      Sri Lanka’s central bank lowered its benchmark lending rate but retained the deposit rate, citing a favorable outlook for inflation but “lacklustre” economic growth that is further widening the gap between actual economic output and potential output.
       The Central Bank of Sri Lanka (CBSL) cut is Standing Lending Facility Rate (SLFR) by 25 basis points to 8.50 percent while leaving the Standing Deposit Facility Rate (SDFR) at 7.25 percent, narrowing to policy rate corridor to maintain short-term rates “at desirable levels with less volatility.”
       It is the central bank’s first easing of its monetary policy stance since April 2015 and comes after three rate hikes since February 2016, most recently in March 2017.
       Only a few economists anticipated the rate cut while most expected CBSL to maintain rates amid political uncertainty after the two main parties in the ruling coalition, the Sri Lanka Freedom Party and the United National Party, lost a local government election in February.
       The rate comes as also comes as capital gains and payee taxes are rising following a new Inland Revenue Act.
       Sri Lanka’s economy grew by only 3.1 percent in 2017 as agricultural output was hit by bad weather, down from 4.5 percent in 2016, for the slowest growth since 2011. In the fourth quarter of 2017 Gross Domestic Product grew by only 1.4 percent from the third quarter.
      “While the Central Bank’s monetary policy easing measure is expected to address near term tepid growth prospects, it is essential that the planned structural reforms are carried out without delay for the economy to move towards a sustained high growth path in the medium term,” CBSL said.
        As part of a US$1.5 billion loan in 2016, the International Monetary Fund and Sri Lanka’s government agreed on reforms to fiscal and tax policy along with a more flexible exchange rate.
        Last month the IMF forecast 4.4 percent growth in Sri Lanka this year, below the central bank’s forecast of 5.0 to 5.5 percent, with inflation seen around 5 percent by end-2018 as food prices stabilize.
        But the IMF also cautioned the country’s economy remains vulnerable to shocks given the size of its public debt so in order to sustain economic growth the reform momentum needs to continue to strengthen policy frameworks and institutions.
        Sri Lanka’s inflation rate eased to 4.2 percent in February, the lowest since November 2016, and the central bank expects inflation to remain within its targets this year, even accounting for the impact from possible changes to administer prices.
        As part of changes to the Monetary Law Act, the CBSL is also moving towards a flexible inflation targeting regime, with inflation targeted at 4-6 percent and the IMF said in March the central bank should remain focused on price stability as its main objective but still stand ready to tighten “if signs of demand-side inflation pressures or accelerating growth appear.”
        In the event of volatile global capital flows, the IMF said exchange rate flexibility should be the first line of defense.
        The Sri Lankan rupee has been depreciating steadily since September 2016 and fell in the first quarter of this year to be down 1.6 percent this year, quoted at 155.95 to the U.S. dollar today.

      The Central Bank of Sri Lanka issued the following statement: