Central Bank expects economy to contract in second half of 2022 as well

The Sri Lankan economy is expected to contract in the second half of 2022 as well, the Central Bank of Sri Lanka (CBSL) has said in a statement.

“As per the GDP estimates published by the Department of Census and Statistics (DCS), the real economy is estimated to have contracted by 4.8 per cent in the first half of 2022, on a year-on- year basis,” the CBSL said.

The country is continuing to be impacted by tighter monetary and fiscal conditions, continuation of supply-side constraints and uncertainty surrounding the business environment amidst shortages of foreign exchange in the domestic foreign exchange market, CBSL said.

“However, a recovery in economic activity is expected in 2023 with the envisaged improvements in the supply-side, along with the timely implementation of the required reforms,” the CBSL said.

Given the current economic situation, the CBSL decided to maintain the Standing Deposit Facility Rate (SDFR) and the Standing Lending Facility Rate (SLFR) at their current levels of 14.50 per cent and 15.50 per cent, respectively.

CBSL announced on Thursday that they arrived at this decision after considering the latest macroeconomic conditions, expected developments and macroeconomic projections.CBSL said that they noted the present tight monetary conditions, the reducing pace of inflation, and both domestic and global factors have helped the country stabilize.

The current fiscal policies are complementing the monetary policy and are helping to mitigate any build-up of aggregate demand pressures, the Bank said.CBSL expects the country’s headline inflation to drop to 4 to 6 per cent over the medium term. The CBSL added that market interest rates are continuously adjusting upwards reflecting the tight liquidity conditions in the domestic money market and the further monetary policy tightening measures introduced thus far.

“With relatively high deposit interest rates offered by licensed banks, a return of currency in circulation to the banking system is also observed. In August 2022, outstanding credit extended to the private sector by commercial banks contracted for the third consecutive month in absolute terms, reflecting the impact of increased effective market lending interest rates, a moderation of economic activity, and measures to curtail non-urgent imports,” CBSL said.

Meanwhile, the current declining trend in the year-on-year growth of credit to the private sector is expected to continue during the remainder of the year, while a similar trend is expected in the growth of broad money (M2b) supply as well. Meanwhile, the need for further monetary financing is expected to reduce gradually, supported by the envisaged fiscal consolidation measures and planned reforms of major state owned business enterprises.

CBSL added that the headline inflation, based on the Colombo Consumer Price Index (CCPI), increased in September 2022, driven mainly by the recent revision of electricity and water tariffs and the increase in Value Added Tax (VAT).

“However, headline inflation is expected to follow a disinflation path in the period ahead. Subdued aggregate demand pressures resulting from tight monetary and fiscal conditions, expected improvements in domestic supply conditions, normalisation in global food and other commodity prices, and the timely pass through of such reductions to domestic prices, along with the favourable statistical base effect, will be instrumental in bringing down inflation over the medium term,” it said.