The Central Bank of Sri Lanka cut its benchmark repurchase rate by 25 basis points to 7.50 percent, saying an expected decline in inflation by the second quarter of 2013 would allow it to ease monetary policy and support the economy so the growth potential can be reached in 2013 and following years.
The central bank, which raised rates twice earlier this year to limit credit growth, also said it would let the ceiling on rupee credit that can be extended by banks expire by year end as it had "served its purpose and such a policy measure may not be required in the near future."
Sri Lanka's inflation rate rose to 9.5 percent in November, equalling this year's high in August, from 8.9 percent in October, mainly due to increases in administered prices and recent tariff adjustments while adverse weather caused high prices of fresh food items.
"Going forward, although the Monetary Board is satisfied that domestic aggregate demand has been contained to moderate levels, it is likely that y-o-y headline inflation could remain somewhat elevated in the immediate months due to supply side factors," the bank said in a statement.
However, the bank added that inflation is expected to moderate toward the second quarter of 2013 and stabilize thereafter due to the strong demand management policies at the start of the year.
The central bank said the rate hikes earlier this year to curtail excessive credit growth and limit demand for imports had helped reduce imbalances in the economy, reduce the monetary expansion and future demand pressures. The bank had also expected a modest slowdown in economic activity, reflected in growth forecasts for 2012 being revised down to 6.8 percent from 2011's 8.3 percent.
Growth of credit to the private sector from banks has continued to decelerate, reaching an annual rate of 23.5 percent in October, down from over 35 percent prior to March.
"This growth is expected to decelerate further to around 19 percent by end 2012," the bank said.
The trade deficit has also declined for the second consecutive month and this trend is expected to continue under the current flexible exchange rate regime.
Sri Lanka's Gross Domestic Product expanded by an annual rate of 6.4 percent in the second quarter, down from 7.9 percent in the first.
The bank expects the economy to expand by 7.5 percent in 2013.