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Sri Lanka: why the unexpected cut?

Sri Lanka’s government says its economy will grow at a zippy 7.5 per cent this year, making it the self-styled fastest growing economy in south Asia.

Yet on Friday morning the central bank suddenly and unexpectedly brought interest rates down by half a percentage point, citing fears of a slowdown. Something doesn’t add up.

Since the end of the island’s long civil war in 2009, Sri Lanka’s economy has been an up and down affair – with two boom years, then economic overheating and a crunching slowdown in 2012.

Central bank governor Ajith Cabraal slammed on the breaks last spring, jacking up interest rates in the face of racing credit growth and a looming balance of payments crisis, while also imposing restrictions on imports.

More recently he has sounded bullish again, claiming that his remedial measures have brought the economy back into balance, leaving the country set to return to more robust growth this year and next, helped along by a strong expansion in areas like tourism and banking.

Until now, that is. Speaking on Bloomberg Television on Friday Cabraal denied that the main impetus for the cuts came from weakening international conditions, pointing to domestic troubles instead.

“We have seen a slight slowdown in our economy, which has been rather disconcerting, and we believe some impetus and some kind of support needs to be given to economy to kick start it once again,” he said.

Many analysts had expected a cut around now, partly to correct for last year’s run of increases, and partly because Sri Lanka’s previously high inflation pressures have eased somewhat over the last few months, as global oil and commodity prices have fallen.

But the half-point drop did come as a surprise – raising suspicions that the central bank might be acting in advance of a few nasty surprises coming down the pipeline.

“I think they are not happy with the first quarter GDP numbers, which they already have access to as policymakers, even though they are not out for the rest of us yet,” Sanjeewa Fernando, head of research at brokerage C T Smith in Colombo, told beyondbrics.

Sri Lanka’s latest growth numbers come out next month, but recent weak trade data suggests they could easily fall below the 6.3 per cent seen in the final quarter of last year, released in March.

This in turn makes it more likely that the island will see growth this year closer to the IMF’s prediction, which is also 6.3 per cent, rather than the racier, region-beating hopes of Sri Lanka’s authorities.

“There have been massive drops exports and imports recently, and so the next quarter could even be below 6 per cent,” Fernando says. “It seems once you’ve slammed on the brakes, its not so easy to get things going again.”

This article by James Crabtree appeared in the Financial Times beyondbrics blog.

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