Economy remains positive, inflation decreases

The outlook for Sri Lanka's economy remains positive with the economy continuing along the high growth trajectory.

Inflation decreased for the third consecutive month in October 2011 with the year-on-year change in the Colombo Consumers' Price Index (CCPI) (2006/07=100) declining substantially from 6.4 percent in September to 5.1 percent in October 2011. Annual average inflation decreased from 7.2 percent in September to 7.1 percent in October 2011. Further, core inflation, on a year-on-year basis, declined from 6.9 percent in September to 5.6 percent in October 2011, signifying the absence of demand-driven inflationary pressures. Inflation is expected to continue to decrease during the rest of the year, benefiting from the improvements in domestic supply conditions, arising from the high growth momentum of the economy.

The fuel price adjustment carried out at end October, and likely corresponding adjustments of costs relating to public and goods transportation, could cause a marginal upward movement in prices. However, going forward, adjusting domestic fuel prices to reflect persistently high international market prices would minimise the adverse impact on future inflation and the economy through reduced price distortions.

Based on provisional data, earnings from exports as well as expenditure on imports grew further on a year-on-year basis in September 2011. The growth of the latter was mainly due to higher imports of intermediate and investment goods, which included project related imports funded through financial inflows to the government that amounted to US $ 1,460 million (Excluding proceeds from the international sovereign bond issue in July 2011) during the first three quarters of the year. Even though the deficit in the trade account has expanded, higher earnings from tourism, increased worker remittances as well as other inflows to the services account helped contain the impact of the trade deficit on the current account balance. In the meantime, during the past month, two commercial banks have made arrangements to infuse fresh capital to the value of US $ 250 million from foreign sources, while approval has been granted to 12 private companies to raise debt capital of approximately US $ 63 million from foreign sources during the past two months in addition to foreign debt capital amounting to approximately US $ 197 million obtained by 14 corporates up to mid-September 2011.

Notwithstanding the above developments, the growth in broad money (M2b) continued into September 2011, with the year-on-year growth remaining high at around 20.7 percent since June 2011. The rapid expansion of credit obtained by the private sector, which has increased by over Rs.37 billion on average per month in 2011, continued to fuel the growth of money supply. Also contributing to the monetary expansion was the increase in net credit to the government by the banking sector.

Considering the above, even though inflation and the inflation outlook remain benign, the Monetary Board is of the view that a change to the existing monetary policy stance is not warranted. Hence, at its meeting held on November 15, the Monetary Board decided to maintain the policy interest rates of the Central Bank and the Statutory Reserve Ratio (SRR) applicable to all rupee deposit liabilities of commercial banks at their current levels. Accordingly, the Bank's Repurchase rate and the Reverse Repurchase rate will be 7.00 percent and 8.50 percent, respectively, while the SRR will be at 8.00 percent.