August, 24, 2023
The Monetary Board of the Central Bank of Sri Lanka, at its meeting held on 23 August 2023, decided to maintain the Standing Deposit Facility Rate (SDFR) and the Standing Lending Facility Rate (SLFR) of the Central Bank at their current levels of 11.00 per cent and 12.00 per cent, respectively.
The Board arrived at this decision following a careful analysis of current and expected developments in the domestic as well as the global economy, while noting the significant easing of monetary conditions effected since June 2023. The Monetary Board took note of the downward adjustment of market interest rates in response to monetary policy easing measures implemented thus far and the need to allow space for further adjustment of market interest rates swiftly.
However, the Board observed that market interest rates of certain lending products remain excessive and are not in line with the current monetary policy stance. Moreover, the Board anticipates a faster reduction in overall market lending interest rates in line with the recent monetary policy easing measures. Accordingly, the Board decided to adopt targeted administrative measures to reduce specific lending interest rates that it considered to be excessive and direct the licensed banks to reduce overall rupee lending interest rates by an appropriate margin in the period ahead.
The disinflation trend continues, with headline inflation reaching single digit levels Headline inflation, measured by the year-on-year change in the Colombo Consumer Price Index (CCPI, 2021=100), decelerated to 6.3 per cent in July 2023, reaching single digit levels for the first time since November 2021. Following a similar trend, headline inflation, based on the National Consumer Price Index (NCPI, 2021=100), also decelerated to 4.6 per cent in July 2023 (year-on-year). The moderation in headline inflation was mainly driven by the softening of energy and food inflation, along with the favourable statistical base effect. Meanwhile, CCPI and NCPI based core inflation, which reflects underlying demand pressures in the economy, moderated to 6.1 per cent and 6.3 per cent, respectively, in July 2023 (year-on-year). Headline inflation is expected to moderate further over the next few months and stabilise around mid-single digit levels over the medium term.
Economic activity is projected to recover gradually during the second half of 2023 and reach its potential level thereafter, supported by the normalisation of monetary conditions, improvements in business confidence, enhancements in supply conditions and the relaxation of import restrictions, and the impact of growth promoting structural reforms. Leading indicators of economic activity point to a lower contraction in GDP in the second quarter of 2023, compared to the previous projections, while the second half of 2023 is expected to record a positive growth, compared to the same period in 2022. However, the impact of weather related disruptions and modest external demand conditions could weigh on expected growth in the near term.
The trade deficit decreased notably during the seven months ending July 2023 with a significant decrease in merchandise imports, despite the decrease in merchandise exports. Earnings from tourism and workers’ remittances, which improved considerably from January to July 2023, in comparison to the corresponding period in the previous year, are expected to improve further in the period ahead. Despite some recent outflows from the government securities market, net foreign investment inflows remained positive during the seven months ending July 2023. In view of the improvements in the balance of payments conditions and the need to support the recovery of activity, the Government relaxed import restrictions related to 638 HS codes, including those of commercial vehicles, since June 2023. Although a significant share of import restrictions has already been relaxed, demand for imports continued to remain subdued, reflecting the tight financial conditions. The Sri Lanka rupee recorded an appreciation of around 12 per cent against the US dollar thus far during the year. The level of gross official reserves was estimated at around US dollars 3.8 billion as at end July 2023, including the swap facility from the People’s Bank of China, while measures were also taken to repay a part of the swap facility with Bangladesh Bank, in addition to the repayment of maturing debt of multilateral lending agencies.
Reflecting the impact of monetary policy easing measures effected since June 2023 as well as the decline in the risk premia with the announcement of the domestic debt optimisation (DDO) operation, market interest rates have declined to a certain extent. A notable reduction was also observed in the yields on government securities. However, the downward adjustment in market lending interest rates has been disproportionate to the reduction effected in market deposit interest rates. Furthermore, despite the considerable easing of monetary conditions, interest rates on certain lending products of some financial institutions continue to remain excessively high posing hardships for individuals and businesses, particularly small and medium scale enterprises. The reduction in the Statutory Reserve Ratio (SRR) from mid-August 2023 is expected to have eased liquidity strains of licensed commercial banks (LCBs) and lowered their cost of funds, facilitating a further downward adjustment in lending interest rates. Meanwhile, based on data available until July 2023, a sustained recovery in credit extended to the private sector by LCBs is yet to be observed. Therefore, it is essential that market lending interest rates are lowered by financial institutions in line with the eased monetary policy stance of the Central Bank, thereby boosting credit flows to the economy, which in turn would help the revival of economic activity.
In consideration of the current and expected macroeconomic developments highlighted above, the Monetary Board of the Central Bank of Sri Lanka, at its meeting held on 23 August 2023, was of the view that it is appropriate to maintain the Standing Deposit Facility Rate (SDFR) and the Standing Lending Facility Rate (SLFR) of the Central Bank at their current levels of 11.00 per cent and 12.00 per cent, respectively. The Members noted that the Central Bank has eased its monetary policy stance considerably since early June 2023 by reducing its key policy interest rates by 450 basis points, while reducing SRR by 2.0 percentage points to inject additional liquidity into the financial markets. Further, the announcement of the DDO strategy also helped reduce the risk premium of yields on government securities, with spillovers to other market interest rates. However, considering the presence of excessive interest rates on certain lending products and the inadequate downward adjustment in market lending interest rates relative to that of deposits, the Board was of the view that the downward rigidity in lending interest rates of certain financial institutions needs to be addressed through administrative measures. Such administrative measures would also ensure the swift transmission of previous monetary policy easing measures to all sectors of the economy. Accordingly, the Board decided to impose caps on interest rates on pawning facilities at 18 per cent, per annum; on pre-arranged temporary overdrafts at 23 per cent, per annum; and on credit cards at 28 per cent, per annum, for all licensed banks. Further, the Board was of the view that penal interest rates need to be capped at 2 percentage points over the regular interest rates charged on the relevant credit facility. In addition to the above, the Board noted that other market lending interest rates on rupee loans and advances should also adjust downwards further, in line with the relaxed monetary policy stance. Directions to effect these regulated interest rates will be issued shortly. These directions will be subject to further review to ensure that the overall lending interest rate structure remains in line with the monetary policy measures of the Central Bank in the period ahead.
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