Sri Lanka is currently facing its worst financial crisis since gaining independence from the United Kingdom in 1948. The country is now awaiting approval of a $2.9 billion bailout package from the International Monetary Fund (IMF) to help it recover. In an effort to secure the bailout, Sri Lanka’s central bank has raised interest rates and relaxed its currency band to move towards a market-determined exchange rate.
On Friday, the central bank raised its standing deposit facility rate and standing lending facility rate by 100 basis points each to 15.5 percent and 16.5 percent, respectively. This was done to tackle inflation and fulfill all “prior actions” required for the IMF bailout. Central bank Governor P Nandalal Weerasinghe is hopeful that the bailout will be approved within this month.
Despite the rate increase, the central bank expects market rates to continue to reduce. On the currency front, the country will gradually move towards a market-driven exchange rate regime. To achieve this, guidance on the currency band will be removed from next Tuesday. The bank has been gradually widening the band throughout this week, to 10 rupees on either side of the spot rate for Friday.
The island nation’s economy has been hit hard by the financial crisis, with growth contracting by an estimated 9.2 percent last year amid soaring inflation that hit 50 percent in February. The central bank raised rates by a record 950 basis points last year to tame inflation and then kept them steady until Friday’s increase.
The Central Bank of Sri Lanka (CBSL) said in a statement that there have been some differences between the CBSL and IMF staff on the inflation outlook. However, given the necessity of fulfilling all the “prior actions” required for the IMF Extended Fund Facility (EFF) arrangement, the Monetary Board and the IMF staff reached consensus to raise the policy interest rates.
Sri Lanka must restructure its debt before IMF disbursements can begin. As part of that process, it has increased interest rates, taxes, and electricity prices, among other measures. This has generated protests from citizens who were already struggling to make ends meet.
Thilina Panduwawala, head of research at Colombo-based Frontier Research, said that the rate increase indicates that the IMF staff are pushing to complete any and all possible domestic actions, hoping they can convince the IMF board for approval of the program. He added that it will probably leave the market confused in the near term than confident, but it depends on whether the market reads this as positive for getting IMF bailout in March.
Sri Lanka is seeking IMF approval under a special Lending Into Official Arrears policy. This allows the global lender to greenlight the program without formal prior financing assurances from China. India and the Paris Club of creditors, the island nation’s other major lenders, have already given their support.