Sri Lanka cuts rates by 250 bps, signals rebound from crisis

Sri Lanka's central bank cut its key interest rates by 250 basis points on Thursday as inflation eased, signalling that the South Asian nation was emerging from a devastating financial crisis and ready for a rebound in growth.

The Central Bank of Sri Lanka (CBSL) cut its standing deposit facility rate and standing lending facility rate to 13% and 14%, respectively, from 15.5% and 16.5% previously.

Most analysts had expected the bank to keep rates steady. The rates are now at their lowest since March 2022, at the start of the crisis.

"Policy interest rates reduced in view of the faster deceleration of inflation, benign inflation outlook and the easing of BOP (balance of payment) pressures, thereby reinforcing the rebound of the economy," the CBSL said.

"The rate cuts are expected to accelerate the normalisation of the interest rate structure, broadbase economic activity and ease pressures in financial markets helping steer the economy towards a rebound phase."

Sri Lanka's key Colombo Consumer Price Indexrose 25.2% on year in May from 35.3% in April, reducing some stress on the crisis-hit economy which has crumpled under soaring inflation caused by its worst financial crisis in over seven decades.

The index peaked at a 69.8% year-on-year surge in September last year. The national inflation rate was at 33.6% in

April, easing from 73.7% in September.

The International Monetary Fund has set Sri Lanka an inflation target of 15.2% for this year but the CBSL is eyeing a more ambitious target of single digit inflation by September.

"Headline inflation is forecast to reach single digit levels in early Q3-2023, and stabilise around mid-single digit levels over the medium term," the bank said.

Thirteen out of the fifteen analysts and economists polled by Reuters had expected the central bank to hold benchmark rates steady at its fourth policy rate announcement this year.

The central bank raised rates by a record 950 basis points last year to tame inflation and by 100 bps on March 3 this year.

"There is a need to bring the interest rates down because the cost of government financing is high," said Udeeshan Jonas, chief strategist at equity research firm CAL.

"The currency appreciation also gives them a bit of leeway to ease rates. However, whether market rates will immediately come down is questionable given that domestic debt restructuring plans are pending."

Sri Lanka secured a $2.9 billion bailout from the IMF in March and aims to complete restructuring debt talks by September, coinciding with the first review by the lender.

The IMF expects GDP to contract 3% this year after a 7.8% contraction last year. The CBSL said it expects domestic economic activity to rebound gradually from late 2023.

"Faster deceleration of inflation and lower probability of excessive demand pressures during the economic rebound phase creates space for a gradual policy relaxation in the period ahead," it said.