Nov 27 2024: The Central Bank of Sri Lanka (CBSL) introduced a new single benchmark rate of 8% on Wednesday, simplifying its monetary framework and easing policy further to support the country’s recovery from a severe financial crisis.
Shift to a Single Rate Framework
The newly introduced Overnight Policy Rate (OPR) replaces the previous dual-rate system, which comprised the Standing Deposit Facility Rate (SDFR) and the Standing Lending Facility Rate (SLFR). While the SDFR and SLFR are no longer policy benchmarks, they remain in use for borrowing or lending with the central bank, set 50 basis points on either side of the OPR.
The shift aims to streamline monetary policy, making it easier for markets to adjust to lower rates and foster economic growth.
Reasons for Easing
The central bank cited several factors for further easing:
- Deflationary Conditions: Deeper-than-expected near-term deflationary pressures.
- Inflation Dynamics: Moderating inflationary pressures and subdued inflation expectations.
- Global Economy: Better-than-expected global economic developments.
- Market Lending Rates: Limited room to lower lending rates further under previous settings.
CBSL Governor P. Nandalal Weerasinghe indicated that future rate decisions would depend on inflation-growth dynamics, external balances, real interest rates, and the output gap.
Economic Recovery and Growth Outlook
Sri Lanka’s economy is gradually stabilizing, supported by a $2.9 billion IMF assistance package secured in March 2023. Growth projections for 2024 range between 4.5% and 5%, slightly exceeding the World Bank’s 4.4% estimate.
Weerasinghe expressed optimism, stating that while the baseline expectation for 2025 is a 3% growth rate, the economy could expand more robustly.
Debt Restructuring Progress
On Tuesday, Sri Lanka launched a long-anticipated $12.55 billion bond swap, a key step in completing its nearly 30-month-long debt restructuring process. Bondholders have until December 12 to vote on the proposal, which involves swapping existing bonds for new issues.
Completion of the restructuring is expected to align the budget with the IMF program, potentially lowering government securities’ interest rates and boosting credit growth.
Market Reaction and Analyst Commentary
While the easing signals continued support for economic recovery, CBSL’s communication hinted that rates may be nearing a bottom.
“Without further policy easing, they did not see further space for market rates to reduce,” noted Thilina Panduwawala, head of research at Frontier Research.
The central bank’s inflation forecasts suggest rising price pressures by mid-2025, which could influence future rate adjustments.
Conclusion
The introduction of a single benchmark rate represents a strategic move by CBSL to simplify policy and stimulate growth amid fragile recovery. However, uncertainties about inflation and global conditions could shape the trajectory of further monetary easing.
