Sri Lanka's Central Bank has raised its overnight policy rate by 100 basis points to 8.75%, marking the largest hike since March 2023. This move, announced on Tuesday, is a response to rising inflation and a depreciating rupee, exacerbated by the ongoing U.S.-Israeli conflict with Iran.
The decision to increase the rate from 7.75% was unexpected by many, as a Reuters poll of economists had predicted a more modest 25 basis-point hike. The Central Bank of Sri Lanka (CBSL) cited the Iran war-driven energy shock, which has led to a 40% increase in fuel prices and subsequent economic strain, as a key factor.
Sri Lanka, heavily reliant on imported fuel, has seen its currency depreciate by 8.7% since early March, although pressures have eased slightly. The country's annual inflation rate has risen from 2.2% in March to 5.4% last month, with expectations that it will remain above the 5% target in the near term.
“This 100bps rate hike suggests the CBSL is shifting gears from supporting growth to defending price stability.”
Udeeshan Jonas, strategy head at CAL
The stock market reacted to the announcement with a 0.5% drop, while the rupee held steady at 327 per dollar. The rate hike indicates a shift in CBSL's focus from growth support to price stability, according to Udeeshan Jonas, strategy head at CAL.
Sri Lanka's reserves have decreased by 3.8% to $6.7 billion in April, driven by a $1.5 billion fuel import bill in the first four months of the year. The IMF's $2.9 billion program is crucial for the country's recovery from the 2022 financial crisis.
Background
Sri Lanka is grappling with economic challenges following a severe financial crisis in 2022. The ongoing conflict in the Middle East has further strained the nation's economy, heavily reliant on imported fuel and vulnerable to global market fluctuations.
The IMF Executive Board is set to meet on Wednesday to decide on a $700 million disbursement to Sri Lanka, which would bolster its reserves. The outcome of this meeting will be critical for the nation's economic stability moving forward.
