“The Monetary Board, at its meeting held on 23 March 2017, was of the view that further tightening of monetary policy is necessary as a precautionary measure, in order to contain the build-up of adverse inflation expectations and the possible acceleration of demand side inflationary pressures through excessive monetary and credit expansion,” the Central Bank said in a statement today.
The Bank raised the interest rates for the first time in eight months.
“The Monetary Board also took into account the notable improvements in fiscal operations, which have resulted in the overall budget deficit in 2016 declining to envisaged levels. The Board was of the view that these improvements, together with the substantial upward movements already observed in market interest rates, have reduced the required adjustment in policy interest rates.”
Meanwhile, Reuters news agency said that the fourth tightening step in 16 months comes two weeks after the International Monetary Fund urged authorities to tighten monetary policy amid heavy foreign outflows from government securities this year.
“Policymakers face a tricky balancing act as the rupee has come under renewed pressure, hurt by capital outflows, but a rate hike is likely to further slowdown an already fragile economy. Growth slowed to a three-year low of 4.4 percent in 2016, easing from 4.8 percent the previous year,” it said.
"There are external pressures like the U.S. raising interest rates, bond outflows and IMF pressure are there to tighten monetary policy," Yohan Samarakkody, head of research, SC Securities (Pvt) Ltd, told Reuters, but added the pace was a bit too fast.
But the central bank said in a statement the move was necessary "to contain the build-up of adverse inflation expectations and the possible acceleration of demand side inflationary pressures through excessive monetary and credit expansion".
A Reuters poll this week showed economists were split on a possible rate hike.
The IMF on March 7 urged the central bank to tighten monetary policy if credit growth or inflation do not abate.
The central bank last tightened monetary policy in July.
Sri Lanka's private sector credit growth remains stubbornly high, which has exacerbated inflation. Credit grew 20.9 percent year-on-year in January, compared with 21.9 percent in December.
Inflation in February hit a record high, pushed up by the impact of a lingering drought.