Sri Lanka’s central bank has significantly stimulated the country’s economy by cutting its key interest rates by 250 basis points.
The decision comes as inflation in the nation eases, signalling that Sri Lanka may be emerging from a severe financial crisis and preparing for a rebound in growth.
The Central Bank of Sri Lanka (CBSL) has lowered its standing deposit facility rate and standing lending facility rate to 13% and 14%, respectively, decreasing from the previous rates of 15.5% and 16.5%. This is the lowest level the rates have been at since the start of the crisis in March 2022.
The CBSL stated that the rate cuts resulted from the faster deceleration of inflation, a positive inflation outlook, and a reduced balance of payment pressures.
The bank believes that the interest rate cuts will contribute to normalising the interest rate structure, encourage economic activity, and alleviate pressure in financial markets, ultimately leading the economy toward a rebound phase.
Sri Lanka has faced significant challenges due to its worst financial crisis in over seven decades, with soaring inflation causing a strain on the economy.
However, the Colombo Consumer Price Index decreased inflation from 35.3% in April to 25.2% in May, offering some relief. The central bank aims to achieve single-digit inflation by September, surpassing the International Monetary Fund’s target of 15.2% this year.
While most analysts expected the bank to maintain interest rates, the decision to cut rates reflects the need to reduce the cost of government financing and take advantage of currency appreciation. However, the impact on market rates remains uncertain due to pending domestic debt restructuring plans.
Sri Lanka received a $2.9 billion bailout from the IMF in March and plans to conclude debt restructuring talks by September.
The IMF predicts a 3% contraction in GDP for this year, following a 7.8% contraction in 2022. The CBSL anticipates a gradual rebound in domestic economic activity starting from late 2023 and believes that the current conditions provide an opportunity for policy relaxation in the future.