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Sri Lanka Unexpectedly Raises Rates to Contain Credit Growth

Sri Lanka's Central Bank Governor Ajith Nivard Cabraal
Ajith Nivard Cabraal, governor of the Central Bank of Sri Lanka. Photographer: Munshi Ahmed/Bloomberg

Sri Lanka unexpectedly raised interest rates to contain credit growth and inflation after the island’s economy expanded the most since at least the 1970s following the end of its decades-long civil war.

The Central Bank of Sri Lanka raised the reverse repurchase rate to 9 percent from 8.5 percent and the repurchase rate to 7.5 percent from 7 percent, the Colombo-based bank said today. All seven economists in a Bloomberg News survey predicted no change. It was the first increase since 2007.

The move underscores central bank Governor Ajith Nivard Cabraal’s confidence that the nation is withstanding the threat from Europe’s debt crisis, which has hurt global demand and spurred policy makers from Australia to Thailand to lower borrowing costs. Sri Lanka’s growth reached 8 percent in 2010 after the resolution of a 26-year civil war in May 2009 lured investments in ports and power plants from countries including China, Japan and India.

“The trends we have seen in credit growth has been quite substantial,” Cabraal said in an interview with Bloomberg Television today. “There has been momentum which is building up fairly strongly, and that’s good for the growth side. But from the stability point of view we have been a little bit concerned that it was growing a little too fast.”

Credit Growth

The benchmark Colombo All-Share Index of stocks slipped 0.3 percent at the close, while the Sri Lankan rupee weakened 0.2 percent to 114.10 per dollar after the central bank today lowered the currency’s trading band.

Sri Lanka devalued the island’s rupee by 3 percent in November to aid exports. Consumer prices in the capital, Colombo, increased 3.8 percent January from a year earlier after gaining 4.9 percent in December.

“The central bank opted to raise rates as they wanted to slow loan growth to get the right inflation and growth equilibrium point,” Sanjeewa Fernando, an analyst at CT Smith Stockbrokers Pvt. in Colombo, said after the decision. “This will help cool demand-side pressures, reduce inflation expectations and ease pressure on the exchange rate.”

Credit granted by commercial banks to the private sector increased by 34.5 percent from a year earlier in December, which “substantially” exceeded projections, the central bank said.

The authority aims to curtail import-related credit to reduce the trade and current-account deficits, and ensure that inflation remains at the “mid-single digit levels” in the second half of 2012, it said today.

‘Healthy Surplus’

“Inflation right now is under control, and we have been encouraged by the trends that we have seen over the past six months,” Cabraal said today. “But going forward, to the latter part of this year and beyond, we do feel that the impact of very big credit growth could have serious repercussions.”

The central bank has decided to direct commercial banks to “moderate” credit disbursements, and monitor the targets for foreign direct investment inflows regularly to enable a “healthy surplus” in balance of payments in 2012, it said.

The International Monetary Fund, which has disbursed $1.75 billion from a $2.6 billion program to boost the Sri Lankan central bank’s reserves, said today it endorsed the decision to raise rates and cool credit demand.

“There was a strong policy response,” Brian Aitken, the IMF’s mission chief for Sri Lanka, said at a briefing in Colombo. “We feel a more flexible exchange rate should be part of the policy package.”

The nation has the “policy space” to manage its current-account deficit, and the IMF is ready to make additional funds available when a review of the economy’s performance against the requirements of the loan agreement is completed, he said. While the country wanted to continue with IMF programs, it had opted not to take the balance of funds, Cabraal said this week.

The end of the civil war has helped lure investments from companies including Shangri-La Asia Ltd. and the Sheraton Group. The Asian Development Bank said this week it plans to lend Sri Lanka $300 million in 2012 to fund public works, including roads, power and water supply projects.

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