Sri Lanka Central Bank Statement

Author: | Published: 19 Oct 2018
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The Sri Lankan economy grew by 3.3% in real terms in 2017 in comparison to a growth of 4.5% in 2016. The moderate growth was mainly due to the contraction in agricultural activities against the backdrop of persistent adverse weather conditions, while there was some slowdown in economic activity in both the services and industrial sectors. In spite of the low real GDP growth, the economy created sufficient employment opportunities that induced a reduction in the unemployment rate to 4.2% in 2017 from 4.4% in 2016. In 2017, Sri Lanka's per capita GDP reached $4,073. Though growth was muted, encouraging progress was made in stabilising the economy.

Sri Lanka's external sector improved gradually in 2017, recording a surplus in the balance of payments. The financial account improved substantially with higher foreign exchange inflows, including foreign direct investment. Amidst these positive developments, the external current account deficit widened in 2017 mainly due to the expansion in the trade deficit, moderation in earnings from tourism and the decline in workers' remittances. However, the gross official reserve position improved considerably to strengthen the country's external buffers. The Central Bank increasingly followed a more market-based exchange rate policy, and the external value of the Sri Lankan rupee remained relatively stable during 2017.

In the fiscal sector, the revenue-based fiscal consolidation programme continued in 2017, aimed at reducing the budget deficit and lowering the government's debt burden. The government's primary account recorded a surplus for only the second time since 1954. However, the overall budget deficit increased marginally to 5.5% of GDP in 2017 due to a drop in expected revenue collection and unanticipated expenditure on disaster relief. Central government debt as a percentage of GDP declined to 77.4% in 2017.

Headline inflation recorded twin peaks in Q2 and Q4 2017 when it was above the desired mid-single digit level due to high food inflation caused by weather related supply disruptions, revisions in domestic taxes and higher global commodity prices. However, core inflation was contained. In order to curtail the build-up of adverse inflation expectations and a possible acceleration of inflationary pressures, the Central Bank further tightened the monetary policy stance by raising policy interest rates by 25 basis points in 2017. In view of tight monetary conditions, interest rates increased both in nominal and real terms, causing a moderation in monetary expansion as well as in private sector credit growth. Headline inflation reverted to mid-single digit levels in early 2018, while core inflation also moderated further. In April 2018 the Central Bank eased its monetary policy stance by reducing the upper bound of the policy rate corridor by 25 basis points. The performance of the financial sector further improved in 2017, while stability was maintained. The banking sector asset base surpassed the Rs10 trillion mark in 2017 and capital adequacy ratios remained at comfortable levels.

Going forward, growth-supporting reforms will remain a priority. Notable progress has already been achieved in terms of enacting several new laws (the Inland Revenue Act, Active Liability Management Act and Foreign Exchange Act). The Extended Fund Facility programme with the IMF also continued in 2017. The government and the Central Bank continued to facilitate the adoption of the flexible inflation targeting regime by 2020 to ensure sustained price stability, thereby supporting a high-growth trajectory in the medium term.