By Swati Bhat Courtesy Reuters

SDFR, SLFR cut by 50 bps each
SRR left unchanged at 5%
Inflation seen below 5% in 2020 (Updates with analyst comment, details)

MUMBAI, Jan 30 (Reuters) – Sri Lanka’s central bank cut both its key interest rates by 50 basis points in an unexpected move on Thursday, citing the need to support an economic recovery.

This is the third time in less than nine months that it has reduced rates, having first cut rates in May following the Easter bomb attacks that triggered a slump in investments and tourism in a blow to domestic growth.

The Central Bank of Sri Lanka (CBSL) lowered the standing deposit facility rate (SDFR) and standing lending facility rate (SLFR) by 50 basis points (bps) each to 6.50% and 7.50%, respectively. The statutory reserve ratio (SRR) was, however, left unchanged at 5%.

Headline inflation, as measured by the year-on-year change in the Colombo Consumer Price index (CCPI), accelerated in December due to domestic supply disruptions.

“In spite of such short-term fluctuations, the near-term forecast suggests that inflation will hover below 5% in 2020, and stabilise between 4%-6% thereafter, assisted by appropriate policy measures and underpinned by well-anchored inflation expectations,” the CBSL said in its policy statement. (bit.ly/2O9GNMg)

Economists were sceptical about the central bank cutting rates at its first monetary policy meeting of 2020, especially after a slew of fiscal-loosening measures taken by the new government over the past two months.

Newly elected President Gotabaya Rajapaksa promised to boost annual growth to 6.5% in his election manifesto. The economy grew 3.2% last year, the slowest pace in 17 years.

It grew at a slow pace of 2.6% in real terms in the first nine months of 2019. The rate of growth for the whole year is likely to be around 2.8%.

Given that credit growth has been picking up in absolute terms since around August/September and overall lending rates have moved lower, this cut may have come in too soon,” said Trisha Peries, product head of economic research at Frontier Research.

It is likely to increase pressures towards end-2020 and into 2021, if there is an excessive build-up in demand conditions.”

The national consumer price inflation rose 6.2% in December, compared with a 4.1% rise in the previous month.

With Thursday’s cut, the central bank has cumulatively reduced its benchmark rates by 150 bps and the SRR by 250 bps, releasing around 150 billion rupees ($832 million) of liquidity into the financial market.

As money market rates have continued to decline albeit at a slower pace, the CBSL said it felt it was essential that the rates should fall further to support a probable pickup in credit growth and economic activity.

The growth of money and credit aggregates is expected to accelerate with the envisaged continued decline in lending rates,” it said.

Analysts said the rate cuts would help growth but at the expense of stability in financial markets, as lower rates put pressure on the rupee and drive foreign funds out of domestic bonds.

The Monetary Board will stand ready to respond to any build-up of demand-driven price pressures in the foreseeable future,” the CBSL said. (Reporting by Swati Bhat; Editing by Shounak Dasgupta and Subhranshu Sahu)