Sri Lanka to keep rates on hold this year - Capital Economics
Emerging Asia Economics

Sri Lanka to keep rates on hold this year

Emerging Asia Economics Update
Written by Sheana Yue

The Central Bank of Sri Lanka (CBSL) left interest rates unchanged today, and while it kept the door open to loosening, high inflation and the CBSL’s concern over the rupee limits the scope for further cuts.

  • The Central Bank of Sri Lanka (CBSL) left interest rates unchanged today, and while it kept the door open to loosening, high inflation and the CBSL’s concern over the rupee limits the scope for further cuts.
  • Having cut rates three times since last May, the CBSL left both its deposit and lending rate unchanged at 6.50% and 7.50% respectively at its meeting today. (See Chart 1.) All seven analysts polled by Bloomberg had forecast that rates would be left unchanged. The statutory reserve ratio (SRR) was held at 5.00%.
  • The accompanying statement made clear that the CBSL didn’t think further easing is necessary. That’s despite highlighting the economic risks of the coronavirus outbreak, which the Bank said “would depend on the extent of the global spread, its persistence and policy responses of major economies and trading partners”.
  • The important tourism sector is already feeling the pain from the virus outbreak and is likely to suffer more over the coming months. The strong recovery in visitor numbers at the end of 2019 has reversed, with tourist arrivals falling -17.7% y/y in February. Those from China collapsed by 92.5%, while tourist arrivals from most other countries also fell. With the recent spike in virus cases globally, the tourism sector is likely to be further hit in the near term. Meanwhile, disruptions to global supply chains and a slowdown in global demand are set to drag on trade and industry.
  • That said, there are a few reasons to think the Bank will leave rates on hold in the coming months. First, the rates at which consumers and businesses can borrow or deposit money have plenty of space to fall further before more policy rate cuts are necessary. (See Chart 2.) In its statement, the Bank highlighted that “there is ample space for market lending rates to reduce without a further adjustment in policy rates at this juncture”.
  • Second, inflation is high. The headline rate rose for the fourth consecutive month in February, to 6.2% y/y, and is now above the Bank’s 4-6% target.
  • Third, the Bank will be concerned about putting pressure on the rupee, which given Sri Lanka’s high debt and external vulnerabilities, tends to come under pressure during period of elevated risk aversion. The CBSL’s statement noted “increased investor appetite for safe haven assets amidst rising global uncertainty”. Sri Lanka’s large burden of FX debt means that the Bank is reluctant to allow large falls in the rupee.
  • Although further easing cannot be ruled out, given that market lending rates have plenty of space to fall, inflation is high and the concerns around the rupee, we think rates are more likely to be left on hold.

Chart 1: Central Bank Policy Rates (%)

Chart 2: Commercial Banks’ Lending and Deposit Rates (%)

Source: Refinitiv

Source: Central Bank of Sri Lanka


Sheana Yue, Research Assistant, +65 6595 1519, sheana.yue@capitaleconomics.com