Home » CB’s interest rate hike boomerangs resulting recession in Sri Lanka

CB’s interest rate hike boomerangs resulting recession in Sri Lanka

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Sri Lanka’s growth rate is now slowing down following the boomerang of the Central Bank’s decision to increase interest rates without safeguards giving way to a recession affecting business and banking activities,economic activists claimed.

Due to rising inflation and lower growth, the Sri Lankan economy is approaching stagflation. Growth expectations for the country have nosedived after the sovereign default with the economy projected to decline by -7.8 per cent in 2022 and -3.7 per cent in 2023.

The International Monetary Fund (IMF) this week forecasted a lower contraction of the Sri Lankan economy than the World Bank.

In its World Economic Outlook (WEO) released this week IMF estimated Lankan economy to contract by 8.7% this year and by 3% next year. However, the World Bank in its forecast released last week estimated a contraction of 9.2% this year and 4.2% in 2023.

Rapid rate hikes were the Central Bank’s response to high inflation that might have been fueled by the easier monetary policy adopted earlier.

There is no one-size-fits-all measure of how quick is too quick, and no way to know whether policymakers have made optimal tradeoffs between growth and inflation except in hindsight.

However Sri Lanka Central Bank Governor Nandalal Weerasinghe has warned that the local businesses will collapse if there was no control of inflation by increasing interest rates under the present circumstances.

The current tight monetary policy helps to control inflation which is the biggest enemy of every one as the skyrocketing of prices has become a major threat to business more than high interest rates, he added.

At the Central Bank monetary policy review media conference on Thursday 06, he noted that 95 per cent of costs of businesses depend on the fluctuation of inflation and not because of interest rates. High interest rate is also a finance cost for businesses but it may be 4-5 per cent and may even go up to 7-8 per cent but 95 per cent of their production costs are for raw materials, transport and wages etc.

Explaining the impact of inflation on businesses, he said that “if the Central Bank cuts the current interest rates by half, then the 5 per cent of finance costs could bring down by half. But the rest of the 95 per cent of production costs can double.

“If we cut rates, inflation can become 100 per cent. Then salaries will have to be raised, raw materials will go up, the exchange rate can further depreciate,” he said.

These production costs would increase as a result of high inflation, and if it continues with runaway inflation then the businesses would definitely collapse Weerasinghe claimed.

These costs will go up as a result of high inflation, he said adding the responsibility of the Central Bank as an independent monetary authority is to control inflation. The country’s economy is expected to shrink around 8 per cent of GDP this year as investment and consumption falls as efforts are being made to stabiliZe the economy.

Sri Lanka will have to manage imports with available inflows instead of seeking bridging finance, Central Bank Governor Weerasinghe said.

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