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Sri Lanka shrugs off inflation fears, holds rates

[Reuters, Tuesday, 8 February 2011 10:19 No Comment]

Sri Lanka’s central bank on Tuesday shrugged off food inflation fears and held interest rates at six-year lows as expected, saying export earnings growth and adequate rice stocks should offset any supply shocks.

Two rounds of heavy flooding that hit the staple rice crop, the first of which came right after the central bank surprised market expectations by cutting interest rates in January, have heightened inflation fears in the Indian Ocean nation.

Sri Lanka’s monetary policy board in its monthly review kept the repurchase rate at 7.00 percent and the reverse repurchase rate at 8.50 percent, the central bank said on Tuesday.

A Reuters poll had forecast the rates would stay unchanged.

Central Bank Governor Ajith Nivard Cabraal said the central bank was closely monitoring supply shocks for any inflation spikes, given the impact of higher global food and energy prices on the island nation’s $50 billion economy.

"Our assessment is there wouldn’t be such a spike. If there is a spike, it will be supply and we will support it with intervention like a tariff reduction," Cabraal told Reuters.

Adequate rice stocks and the potential for a larger crop in the May-September growing season "are likely to ease any prices pressures in 2011", the central bank said in a statement.

"The recent price surges in other food crops are expected to subside as the situation normalises in the coming months," it said, referring to flood-damaged crops.

SUPPORTING GROWTH

Barely two years after it won a quarter-century separatist war, the government is working to spur corporate expansion and capitalise on solid performance under a $2.6 billion International Monetary Fund loan to bring in outside investment.

It is also keen to keep economic growth humming along, after hitting an estimated 8 percent last year and forecasting 8.5 percent this year. The IMF was more conservative, estimating growth at 7 percent this year.

"This is mainly to support growth rather than attracting investments," said Anushka Shah, an economist at Citibank in Mumbai. "With an increase in inflation, the central bank may have to hike the rate towards the end of the year."

Since early 2009, the central bank has pushed interest rates lower and urged banks to drop the spread to cut borrowing costs, after tackling inflation that surged to 28.2 percent in June 2008 with a tight monetary policy stance.

Analysts have said the central bank’s relaxed policy has yet to encourage corporate investment as loans taken for consumption are still high, but Cabraal said most of Sri Lanka’s companies have adequate cash for their own expansion.

Private credit growth shrank in 2009 as the corporate sector postponed its investment plans due to low global demand, but by the end of 2010 it had hit 24 percent, well past the central bank target of 15 percent, Cabraal said.

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