Sri Lanka's central bank held its policy rates steady, as expected, saying the economy was on track to meet its forecast of 7.8 percent growth this year while inflation was expected to remain in mid-single digits during 2014.
The Central Bank of Sri Lanka also said external trade continued to remain buoyant in April despite a modest decline in import spending, which resulted in a smaller trade deficit. Inflows from workers' remittances remained robust along with a significant increase in earnings from tourism.
Together with the inflows from the proceeds of Sri Lanka's seventh international bond in mid April, gross official reserves rose to a record US$ 8.9 billion end-April, up from $8.1 billion at the end of March.
"In view of the increased foreign currency inflows, the Central Bank also absorbed around US dollars 550 million form the domestic foreign exchange market," the bank said.
Sri Lanka's inflation rate eased to 3.2 percent in May - its lowest level since February 2012 - from 4.9 percent in April, below the central bank's 2014 target of 4-6 percent inflation. In 2015 and 2016 the central bank will target inflation of 3-5 percent. Core inflation in May was 3.3 percent.
Sri Lanka's Gross Domestic Product expanded by an annual rate of 7.6 percent in the first quarter, down from 8.2 percent in the fourth quarter but up from 6.1 percent in the first quarter of 2013.
"Going forward, the growth momentum is likely to continue during the remainder of the year with improved global economic conditions and expected improvements in domestic credit conditions enabling the economy to achieve the envisaged growth of 7.8 percent for 2014." the bank said.
Last year Sri Lanka's economy expanded by 7.3 percent, up from 6.3 percent in 2012, and the International Monetary Fund has forecast 7.0 percent growth this year.
The central bank said broad money growth was dampened due to subdued credit demand from the public sector and a deceleration of private sector credit by the banking sector. It said the continued moderation of growth of credit to the private sector seemed to reflect the customary transmission lag of around 18 months and the contraction in gold-backed loans since April 2013.
"However, with the realization of the effects of the eased monetary policy stance, a turnaround in credit growth could be expected in the second half of the year," the bank said.
However, the bank's board "decided to urge banks to lower their market lending rates," continuing its recent campaign to get commercial banks to pass on the effects of its rate cuts.
The bank said rates on bank deposits had been reduced but lending rates still had not adjusted to the decline in deposit rates, with corporates increasingly resorting to alternative sources of financing, such as corporate debt and equity issuance, suppliers' credit, and funds raised from abroad.
The bank said its view was that an expansion in bank credit would be beneficial for continued economic growth and its view is that banks have adequate space to tighten the spread between lending and deposit rates to "a more reasonable level."
The central bank embarked on an easing cycle in December 2012 and has cut the repo rate by a total of 125 basis points, most recently in October 2013. In January the bank rejigged its policy framework with the Standing Deposit Facility Rate (SDFR) replacing the repo rate.
The SDRF rate was maintained at 6.5 percent and the Standing Lending Facility Rate (SLFR) was left at 8.0 percent.