Sri Lanka's central bank surprised markets on Wednesday by cutting key monetary policy rates for the first time in nearly two years in order to boost economic growth as inflation pressures were expected to ease.
The bank reduced the repurchase rate and the reverse repurchase rate by 25 basis points to 7.50 percent and 9.50 percent respectively, lowering them from three-year highs.
A Reuters poll of 13 analysts had expected that both rates would remain unchanged.
The central bank had kept rates steady since April, following two hikes made earlier in the year when Sri Lanka also adopted a flexible exchange rate policy as part of a strategy to counter a balance-of-payments deficit.
Central Bank Governor Ajith Nivard Cabraal said the bank originally expected to make cuts from January, but reduced inflationary pressures had prompted the bank to move more quickly to a pro-growth stance so that people could make spending and investment plans based on lower rates.
"The demand-driven inflation is subdued," Cabraal told Reuters. "There is no need to prolong it. It's an impetus now and the people can get ready with the plans ahead of the next year."
Headline inflation is expected to moderate by the second quarter of 2013 after hovering around the current level due to supply side shocks, the central bank said in a statement.
Annual inflation has risen due to a supply shortage mainly in foods, and notched three-month high of 9.5 percent in November, compared with 8.9 percent in October. That is still below the 42-month high of 9.8 percent struck in July due to an extended drought that hit the farm sector during the preceding months.
"You don't deal with such inflation through interest rates or credit curtailment. So it made a lot of sense for us to take the decision," Cabraal said. "The government's tightening of the fiscal deficit also has helped towards inflation control."
Sri Lanka last month said it will achieve a fiscal deficit of 6.2 percent of gross domestic product (GDP) this year, a target agreed with the International Monetary Fund under a $2.6 billion loan, lowering the deficit from 6.9 percent in 2011. The government aims to bring the deficit down to a 35-year low of 5.8 percent next year.
The central bank wants to help reverse a slide in the economic growth rate, aiming for a 7.5 percent growth next year. It has forecast gross domestic product will grow 6.8 percent this year, slowing from a record 8.3 percent in 2011.
The bank also announced that a rule restrcting commercial banks credit annual growth to 18 percent, that was brought in last year, would be ditched at the end of this month.
The bank said it expected the private sector credit growth to have decelerated to around 19 percent year-on-year from a near 16-year high of 35 percent in March.
Samatnha Amarasinghe, an economist with Standard Chartered Bank in Colombo, expected further rate cuts, but with inflation still at high levels she expected the central bank to wait at least a few months.
"We may not see cuts in the first quarter again, but we expect another 50 basis points next year," she said.
The rate cut had little impact on the share market, while the rupee currency was barely changed at 128.75/80 per dollar. Just a tad firmer than Tuesday's close of 128.80/90.