Sri Lanka central bank holds key rate at 8.75%

Sri Lanka's central bank maintained its key interest rate at 8.75% on Wednesday, ahead of the island nation's budget in mid-November. The decision mirrored market expectations after the country raised its policy rate by 100 basis points in May to stabilize its currency and safeguard foreign exchange reserves amid the US-Israeli conflict in Iran.

Inflation surged to an 8% annual rate in August, up from 7.3% in July, as higher energy costs from the war led Sri Lanka to ration fuel and hike prices by roughly 35% since March. The Central Bank projected headline inflation to stay in the high single digits through the first quarter of 2027 before easing towards a 5% target.

Central bank officials stated that despite the recent inflation spike, medium-term inflation expectations remain aligned with the 5% goal. The bank noted that Sri Lanka's remittances and tourism revenues are resilient, with the current account projected to be in surplus in August after four months of deficits. Udeeshan Jonas, chief strategist at equity research firm CAL Group, suggested that early tightening has curbed demand, halting runaway inflation and boosting the current account to positive territory.

The nation is currently negotiating with the International Monetary Fund (IMF) on the seventh review of its Extended Fund Facility program, which could result in a $330 million release in November following the national budget presentation in parliament. The IMF has forecasted a 3% economic growth for Sri Lanka this year, following a 4.7% growth in the first half of 2023.