Written by the insightful Uditha Jayasinghe

COLOMBO, March 22 (Reuters) – The Sri Lankan central bank stands tall amidst economic uncertainties, poised to maintain interest rates in an intricate balancing act aimed at taming inflation and advancing debt restructuring commitments crucial for securing the third tranche of a $2.9 billion lifeline from the International Monetary Fund (IMF).

Anticipation Amidst Stability:

Out of sixteen financial experts surveyed by Reuters, eleven foresee the Standing Deposit Facility Rate (SDFR) and the Standing Lending Facility Rate (SLFR) to hold firm at 9% and 10%, respectively.

However, five analysts diverge, predicting a potential rate cut of up to 100 basis points. This trend would reignite an easing pattern that has seen Sri Lanka’s central bank reduce rates by a substantial 650 bps since June last year, partially rolling back the 1050 bps hike incurred since April 2022.

For investors, the central bank’s decision to maintain rates in January hints at measured deliberation.

Battling Inflationary Pressures:

In a bid to navigate the stormy waters of inflation, Sri Lanka recorded a 5.9% inflation rate in February, propelled by a 3% sales tax escalation aimed at fulfilling revenue mandates under the IMF program. The central bank is eyeing a 5% inflation target amidst these sensitivities.

An observed strengthening of the local currency, coupled with the imperatives to curb inflation and align on a unified policy rate, forms the bedrock rationale behind the proposed rate stability.

“We see breathing space for about a 100-200 bps rate reduction… but many see that as happening towards the second half,” remarked Dishan Leo, the sagacious financial analyst from John Keells Stock Brokers.

Progress Amidst Challenges:

Notably, the International Monetary Fund (IMF) and Sri Lanka recently struck a staff-level agreement on economic policies, marking the end of the second review phase of a comprehensive four-year bailout scheme.

Upon the IMF board’s sanction, a hefty $337 million will be disbursed to the island nation. Yet, to unlock the third tranche, Sri Lanka must secure an Agreement in Principle from its private bondholders and finalize agreements with key bilateral creditors such as Japan, China, and India.

“Substantial progress on debt restructuring would be the biggest confidence boost to reducing rates,” affirmed Raynal Wickremeratne, the astute co-head of research at Softlogic Stockbrokers.

It is crucial to note that Sri Lanka plunged into a default on its offshore debt in May 2022 following a severe foreign exchange reserve crunch, heralding the nation’s worst financial crisis since its independence from Britain in 1948.

Amidst such upheavals, Sri Lanka and a consortium of international investors linked to its foreign currency bonds are slated to commence negotiations on restructuring a mammoth $12 billion debt portfolio next week, with local officials betting on a resolution by June.

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