Sri Lanka raises rates amid record inflation, despite economic contraction

People walk past the main entrance to the Central Bank of Sri Lanka in Colombo, Sri Lanka March 24, 2017. REUTERS/Dinuka Liyanawatte

COLOMBO, July 7 (Reuters) – Sri Lanka hiked interest rates to their highest level in two decades on Thursday, saying it needed to stem runaway inflation to avoid hurting an already struggling economy further. and in decline.

Sri Lanka’s central bank raised its standing lending facility rate (LKSLFR=ECI) by 100 basis points to 15.50%, while the standing deposit facility rate (LKSDFR=ECI) was also raised at 14.50%, the highest since August 2001.

Inflation hit a year-on-year high of 54.6% in June, and central bank governor P. Nandalal Weerasinghe said it could reach 70%, prompting the central bank raise interest rates to cope with rising prices.

“We will work to manage inflation as much as possible, but other measures such as cash transfers will also be needed to provide relief to the poor,” he told reporters.

Rising interest rates, however, would further dampen the island nation’s economic growth.

The country is struggling to pay for food, medicine and fuel, with foreign exchange reserves at an all-time high. The economy contracted 1.6% year on year in the first quarter and is expected to shrink further in the second.

Sri Lanka is pushing for a possible $3 billion extended financing package from the International Monetary Fund (IMF), which would help it unlock other bridging financing options to pay for essential imports.

The central bank said in a statement that significant progress has been made in talks with the IMF, while negotiations are underway with bilateral and multilateral partners to secure bridge financing and ease the reserve gap.

“One of the recommendations of the IMF program is to support the poor and vulnerable, as high inflation will have the greatest impact on them,” Weerasinghe said.

The central bank expects inflation to hit 70% in the near term and stay higher for another year, but a drop in global crude and commodity prices could help push it down sooner, a- he added.

The central bank estimates a contraction in growth of 4% to 5% this year, Prime Minister Ranil Wickremesinghe told parliament on Tuesday, although the government is targeting a smaller contraction of 1% in growth next year.

“There has been a shift in stance from the central bank, perhaps as a result of discussions with the IMF,” said Dimantha Mathew, head of research at First Capital.

“I don’t think they care about growth at all and have focused on easing monetary pressure and printing money to stabilize the economy,” he added.

The central bank also said ensuring external sector stability and overall macroeconomic stability would require the commitment of all stakeholders and called for consistent and consistent action, including from the government.

“A faster implementation of the expected tax reforms aimed at strengthening the rationalization of government revenues and expenditures is necessary,” he said, adding that improving the financial situation of public enterprises was also essential.

He said these measures would over time lead to a decline in the government’s financing needs and help to reduce monetary financing at a faster pace.

Sri Lanka is due to present a draft budget to parliament in August, which will include new tax measures and spending cuts, Wickremesinghe told parliament last month.

The IMF indicated the need for stronger fiscal measures to put public finances back on track and strengthen debt sustainability after a ten-day visit to the country late last month.

Sri Lanka hopes to hold a donors’ conference with the participation of China, India and Japan after reaching a staff-level agreement with the IMF and will present its debt sustainability framework by August .

Editing by Raju Gopalakrishnan and Alexander Smith

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