Tight monetary conditions in terms of high interest rates are essential at this juncture to curtail the prevailing high inflation, Central Bank Governor Dr. Nandalal Weerasinghe said.
He said that lowering interest rates now could delay the disinflation process which would require a larger and more painful and upward adjustment in interest rates once again. Explaining further, the Governor stated that the hardships faced by the people and businesses during the disinflation process are expected to be temporary, but any delay in this disinflationary process will prolong and aggravate these hardships for all segments of the country. Dr. Weerasinghe expressed hope that interest rate will be normalized once price stability is stabilized.
The headline inflation is expected to follow a disinflation path with a sharper decline projected from early 2023. However, inflation edged up in September 2022, driven by the recent revision of electricity and water tariff and increase in VAT.
Food, energy and transport components drove the acceleration of headline inflation in mid 2022, however, contribution from food , energy and transport components to headline inflation has gradually reduced in recent months. The Central Bank expects headline inflation to come down over medium term due to subdued aggregate demand pressures resulting from tight monetary and fiscal conditions, expected improvements in domestic supply conditions, normalisation in global food and other commodity prices, and the timely pass through of such reductions to domestic prices, along with the favourable statistical base effect.
Speaking on the progress of IMF negotiations, Governor said Sri Lankan authorities are fast tracking negotiations with bi-lateral partners and representatives of commercial creditors to advance the debt restructuring process, subsequent to staff level agreement reached with the International Monetary Fund for a loan of $2.9 billion, which would be disbursed over a period of four year under Extended Fund Facility (EFF) arrangement to help restore economic stability.
“Discussions are ongoing and we would continue that process with the relevant parties. Once we can get the financial assurance from the creditors, we can go to the IMF executive Board and get the program approved.” Governor Weerasinghe said.
Despite economic activity expected to remain subdued during 2022, the Central Bank expects a recovery in Sri Lanka’s economy in 2023 with the envisaged improvements in the supply-side, along with the timely implementation of the required reforms. Nevertheless, the economy is expected to contract in the second half of 2022 as well owing to tighter monetary and fiscal conditions, along with the continuation of supply-side constraints and uncertainty surrounding the business environment amidst shortages of foreign exchange in the domestic foreign exchange market, among others.
The merchandise trade deficit contracted significantly during the first eight months in 2022, compared to the corresponding period in 2021, owing to the impact of non essential imports restrictions and an increase in export earnings. Moreover, the Central Bank says there has been improvement in monthly workers’ remittances. In addition, an improvement in foreign exchange liquidity in the domestic banking system has been observed supported by increased inflows in the form of export proceeds and workers’ remittances.
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