Sri Lanka Unexpectedly Cuts Interest Rates After EU Denies Trade Benefits

Sri Lanka’s central bank unexpectedly cut its benchmark interest rates for the first time in eight months to support economic growth after the European Union withdrew trade concessions this week.

The Central Bank of Sri Lanka reduced the reverse repurchase and repurchase rates by a quarter-point to 9.5 percent and 7.25 percent, respectively, according to a statement on the Colombo-based bank’s website today. Only one of four economists surveyed by Bloomberg News predicted the decision.

Governor Ajith Nivard Cabraal has room to keep borrowing costs low as higher farm output helped slow inflation for a fourth month in June. The EU on July 5 announced it will temporarily deny preferential trade access to Sri Lanka from Aug. 15, saying the country failed to respond to European pleas to improve its human rights record. Exports make up about a fifth of Sri Lanka’s $41 billion economy.

“The government wants to step up growth as risks to exports emerge,” said Saminda Weerasinghe, a research manager at Acuity Stockbrokers Pvt. in Colombo. “Inflation is under control and that helps boost consumer demand.”

The monetary policy decision was announced after the nation’s financial markets closed. The benchmark Colombo All- Share Index fell 0.4 percent to 4,505.69 today. It has climbed 33 percent this year and is the best performer after Mongolia and Bangladesh in the Asia Pacific. The Sri Lankan rupee was little changed at 113.43 against the dollar.

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Cabraal’s move contrasts with his counterparts in South Korea, India, Malaysia and Taiwan, who have raised rates in recent weeks as Asia leads the global economic recovery.

Acuity’s Weerasinghe said Sri Lanka needs low borrowing costs to rebuild the nation’s war-torn northern and eastern parts after the Liberation Tigers of Tamil Eelam rebels were defeated in May 2009, ending a 26-year separatist struggle.

Land recovered from the Tamil Tigers-controlled areas has enabled farmers to expand cultivation, helping drive down the inflation rate to less than half the average pace of the five years through 2009.

Paddy production in the September-to-March season rose 9 percent to an unprecedented 2.6 million tons, according to the statistics department.

Consumer prices in the capital, Colombo, rose 4.8 percent in June from a year earlier after a 5.3 percent gain in May.

“Going forward, inflation is expected to remain subdued, at single digit levels, during the remainder of the year,” the central bank said today.

Sri Lanka is aiming to accelerate growth to 7 percent in 2010, the fastest pace since 2006, to cut poverty in a country where the World Bank estimates almost half the population lives on less than $2 a day.

Prospects of faster growth are attracting overseas companies to Sri Lanka.

HSBC Holdings Plc, earlier this year, opened the first branch by any foreign bank in Jaffna, the former stronghold of the Tamil Tigers. Minor International Pcl, Thailand’s biggest hotel operator, announced plans in May to invest in Sri Lanka to tap growing leisure and business travelers.