Cash-strapped Sri Lanka raised interest rates to the highest level in two decades on Thursday, saying it had to head off runaway inflation to avoid even deeper pain for an economy that is already in crisis and is shrinking.
The Sri Lankan central bank increased its standing lending facility rate by 100 basis points to 15.50% while the standing deposit facility rate was similarly raised to 14.50%, the highest since August, 2001.
Inflation touched a year-on-year record of 54.6% in June, and central bank Governor P Nandalal Weerasinghe said it could go as high as 70%.
Interest rate rises, however, would further dampen economic growth in the island nation.
The country’s economy contracted by an annual 1.6% in the first quarter and is forecast to have shrunk more in the second.
Sri Lanka is pushing for a possible $3 billion extended financing programme from the International Monetary Fund (IMF).
The country is officially out of petrol and diesel, while fresh supplies are at least two weeks away.
The government defaulted on its $51 billion foreign debt in April and is negotiating a possible bailout with the IMF.
The central bank said significant progress had been made in talks with the IMF, while negotiations are underway with bilateral and multilateral partners to secure bridge financing and ease the shortfall in reserves.
It expects inflation to touch 70% in the near term and stay higher for another year but a fall in global crude and commodity prices may help bring it down sooner, Weerasinghe said.
The central bank estimates a contraction in growth of 4% to 5% this year, Prime Minister Ranil Wickremesinghe told parliament on Tuesday, although the government targets a smaller contraction of 1% in growth next year.
The central bank also said ensuring external sector stability and overall macroeconomic stability would require commitment from all stakeholders and it called for coherent and consistent action, including from the government.
"Faster implementation of the expected fiscal reforms aimed at strengthening government revenue and expenditure rationalisation is needed," it said, adding that improvements in the financial position of state-owned enterprises were also key.
It said these measures would over time would lead to a decline in government financing needs and help scale down monetary financing at a faster pace.
The IMF indicated the need for stronger fiscal measures to put public finances back on track and boost debt sustainability following a ten-day visit to the country late last month.
Sri Lanka hopes to hold a donor conference with the involvement of China, India and Japan after a staff-level agreement is reached with the IMF and will present its debt sustainability framework by August.