Sri Lanka vowed to soon restore a flexible exchange-rate regime after unexpectedly raising its benchmark interest rate Friday as the troubled nation looks to secure a $2.9 billion International Monetary Fund bailout to steady its economy.
(Bloomberg) — Sri Lanka vowed to soon restore a flexible exchange-rate regime after unexpectedly raising its benchmark interest rate Friday as the troubled nation looks to secure a $2.9 billion International Monetary Fund bailout to steady its economy.
“Sri Lanka’s rupee will be fully market-driven from next week,” Governor Nandalal Weerasinghe said at a press briefing after the Central Bank of Sri Lanka increased the standing lending facility rate by 100 basis points to 16.5%, the highest since August 2001. All eight economists in a Bloomberg survey expected the authority to extend a pause.
The twin moves reflect the nation’s commitment to clinch the IMF loan that’s counted on to unlock more funding, shore up foreign-currency reserves, ease supply shortages and help revive the $81 billion economy in recession. Similarly situated Pakistan on Thursday jacked up borrowing costs by 300 basis points.
In the past months, Sri Lanka has increased taxes and cut energy subsidies to meet the fund’s conditions, although such steps could also rekindle inflation that has come off from a peak of almost 70%.
“There have been some differences between the CBSL and IMF staff on the inflation outlook,” the central bank said in a statement announcing the rate hike. The authority had stood pat since August to allow previous tightening to damp demand in the economy.
But the IMF was of the view that more action was needed, the central bank said. “Given the necessity of fulfilling all the ‘prior actions’ in order to move forward with the finalization of the IMF Extended Fund Facility arrangement,” CBSL said it “reached a consensus” with the lender to increase by a quantum that was smaller than originally discussed.
The rate increase shows the central bank’s “commitment to reduce inflation more quickly and firmly towards the single-digit target,” senior mission chief Peter Breuer and mission chief Masahiro Nozaki said in an emailed statement. “Durable disinflation would help boost market confidence, reduce excessive risk premia and ease the financing conditions for the corporates, especially the small and medium enterprises, which supports recovery.”
Earlier on Friday, the nation loosened its grip on the rupee for a third time this week, prompting a rally. The local currency extended gains to 8% this week, after it suffered a 45% slide in 2022.
While gains in consumer prices slowed after 950 basis points of CBSL interest-rate tightening last year, Sri Lanka continues to have Asia’s quickest inflation at above 50%.
IMF loan programs that have been pending for months in Sri Lanka and Pakistan are seen to address near-term challenges.
But those bailouts have strings attached, such as ensuring sustainable revenue and enabling market-determined exchange rates that have led to a spate of energy price increases and tax hikes. Sri Lankan workers, including the central bank’s trade unions, on Wednesday protested higher income taxes.
What Bloomberg Economics Says…
The Central Bank of Sri Lanka’s surprise decision to hike rates at its March meeting reflects a necessity of fulfilling International Monetary Fund demands in order to receive aid from the organization. The rate hike, however, may do more harm than good for the economy.
-Ankur Shukla, India economist
For the full note, click here
Friday’s decision would also help lower the spread between policy interest rates and high market interest rates, CBSL said. As the debt restructuring progresses, the risk premium should ease and market rates should go down, it said.
–With assistance from Devidutta Tripathy, Asantha Sirimanne, Pradeep Kurup, Shwetha Sunil, Zoe Schneeweiss, Eric Martin and Ana Monteiro.
(Updates with comment from IMF official in seventh paragraph.)
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