Sri Lanka’s crafty rate cut

by James Crabtree

Having been forced into a dramatic interest rate hike earlier this year to fend off a balance of payments crisis, Sri Lanka’s central bank has made more small waves in the south Asian tourist island this morning, with a rate cut.

The move caught out local analysts, as there had been no hint of a change in policy in recent weeks.

A hastily-produced note from Colombo-based brokerage CT Smith explained:

In an unexpected move, the Central Bank of Sri Lanka (CBSL) reduced its repo and reverse repo rates by 25bps each to 7.5% and 9.5% respectively today, after adopting a tight monetary policy since April 2011…. the rate cut came in as a surprise with country’s headline inflation remaining sticky at high single digits.

On a trip to Sri Lanka in October, the FT was granted an audience with central bank governor Ajith Cabraal, who stressed his plans were to hold things steady until well into next year. So what has changed?

The first thought might be that Sri Lanka’s economy needed a boost as it is one of several Asian emerging economies that have recently come off the boil, including India, its much larger neighbour to the north.

But while the island’s growth has indeed slowed over the last year, after two boom years following the conclusion of the nation’s two-decade long civil war in 2009, most analysts project that the economy will tick along nicely at above 6 per cent next year.

Instead it seems the central bank governor may be indulging in a spot of statistical chicanery, taking advantage of the after-effects of the policy changes he introduced earlier this year, which were designed to stop the domestic economy overheating.

“Earlier in 2012 inflation jumped much higher, as the government raised fuel prices and allowed its currency to depreciate, which fed through into prices,” explains Prakriti Sofat, an economist at Barclays, who follows Sri Lanka.

“In the first half of 2013, given the high base inflation numbers will look much better, which the central bank believes is giving them some room to ease, although it does feel a bit premature.”

Either way, the move is likely to be a boost for the government of President Mahinda Rajapaksa, who remains popular domestically, despite rising concerns abroad about his increasingly authoritarian style, and scant progress on reconciliation with the defeated Tamil population in the island’s north.

Worries about Rajapaksa’s rule have of late focussed on his attempts to impeach the island’s chief justice, part of what many observers characterise as an ongoing attempt to weaken the island’s democratic institutions, and cement the control of the Rajapaksa family.

But so long as the island’s economy is purring along, the grip on power wielded by Rajapaksa, alongside his two powerful brothers, is only likely to tighten.

source - http://blogs.ft.com/beyond-brics/2012/12/12/sri-lankas-crafty-rate-rise/#axzz2EqbV2xUg