Sri Lanka Central Bank Statement

Author: | Published: 5 Sep 2017
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The Sri Lankan economy registered a growth of 4.4% in 2016, in real terms, in comparison to a growth of 4.8% in 2015. Services and industry related activities contributed to economic growth, while unfavourable weather conditions triggered a contraction in agriculture in 2016. The unemployment rate declined to 4.4% in 2016 from 4.7% in 2015, owing to the expansion in industry and services. Despite the uptick in inflation in certain months due to supply side disruptions and upward adjustments in the tax structure, inflation broadly remained at mid-single digit levels.

External sector performance remained challenging during 2016, and some deterioration of the balance of payments was observed. Inflows to the current account in the form of earnings from tourism and workers' remittances helped cushion the larger trade deficit. Direct investment inflows remained moderate and rising global interest rates resulted in capital outflows from the government securities market. Although the exchange rate was broadly stable during the early part of the year due to intervention by the Central Bank, the exchange rate was increasingly allowed to reflect market conditions thereafter. Greater flexibility in the exchange rate is also expected to improve the competitiveness of the economy.

The fiscal sector witnessed notable improvements with government efforts towards fiscal consolidation. Accordingly, budgetary operations improved in terms of revenue and expenditure, containing the overall budget deficit at 5.4% of GDP compared to 7.6% in 2015. The broadened tax base, along with several structural reforms in tax administration, supported the increase in government revenue, while efforts to rationalise recurrent expenditure and prioritise capital expenditure reduced government expenditure. Nevertheless, the central government debt to GDP ratio edged up to 79.3% in 2016 mainly due to the increase in net borrowings and the modest economic growth during the year.

The financial sector continued to expand during the year, whilst exhibiting resilience amidst challenging market conditions both globally and domestically. The asset base of the banking sector expanded, while capital and liquidity levels were maintained well above the minimum statutory requirements. The Central Bank initiated several measures to strengthen the supervisory and regulatory framework for financial institutions. Meanwhile, a regulatory framework for the microfinance sector was introduced in 2016.

The Central Bank continued to tighten the monetary policy stance in 2016, in view of possible emergence of demand-driven price pressures. Accordingly, in addition to the increase in the Statutory Reserve Requirement in early 2016, policy interest rates were also increased by a total of 100 basis points in two steps. Responding to policy measures, monetary expansion slowed somewhat in 2016, but remained higher than the envisaged level. Accordingly, the Central Bank further tightened its monetary policy stance in March 2017. It is expected that with these measures, money and credit growth will decelerate to envisaged levels by end 2017.

Moving ahead, monetary policy formulation of the Central Bank is expected to be based on a Flexible Inflation Targeting framework to maintain inflation at mid-single digit levels in the medium term. The continuation of the Extended Fund Facility (EFF) programme with the International Monetary Fund, while attracting other non-debt creating financial inflows, would support the balance of payments and the country's reserve position. Frameworks being introduced to strengthen macroeconomic policy making and structural reforms to boost the growth framework are expected to support a higher growth trajectory in the medium term.




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