Sri Lanka’s Inflation Trend amid Economic Crisis and IMF Bailout

Summary

  • In December, food prices increased by 1.6% after witnessing a 2.2% drop in November 2022, according to the Department of Census and Statistics.
  • On the contrary, non-food items experienced a 6.3% decrease in prices in December, down from 7.1% YoY in November.
  • The National Consumer Price Index (NCPI) which measures overall retail price inflation, recorded an increment from 2.8% in November.
  • Sri Lanka endured maximum inflation reaching 70% in September 2022, propelled by the most severe financial crunch the country has experienced in years, majorly instigated by a nosedive in foreign reserve currencies.
  • Sri Lanka’s inflation saw a declining phase from June subsequent to the $2.9 billion IMF bailout, but it is predicted to increase as of January due to the 3% value-added tax increase to meet IMF’s revenue goals.
  • Measures undertaken to enhance the state’s finances, inclusive of an 18% power cost upswing in October, strive to control inflation.
  • Despite the tax augmentation, Dimantha Mathew from First Capital Research projects that inflation will settle just under 5% by the end of January, owing to a persistent decremented demand.
  • The Central Bank of Sri Lanka (CBSL) anticipates maintaining its governing policy rates without modifications to manage inflation, after reducing interest rates by 650 basis points starting its mitigating cycle in June 2023, aimed at boosting the economic retrieval from last year’s recession.

Inflation Fluctuations and Predictions

In December 2022, food prices recorded an increment of 1.6%, rebounding from a 2.2% fall in the previous month, according to an announcement from the Department of Census and Statistics. Simultaneously, prices of non-food items witnessed a 6.3% decline in December from a 7.1% year-on-year fall in November.

The NCPI, a key indicator of broad retail price inflation, which is released on a 21-day delay every month, observed an increase from 2.8% in November.

Economic Concerns and IMF Involvement

Sri Lanka was blighted by historic high inflation of 70% in September 2022, following the country’s harshest financial crisis in decades, primarily caused by a dramatic decrease in foreign exchange reserves. The IMF assisted with a $2.9 billion bailout, which led to a decrease in inflation from June. However, an expected increase is predicted from January as a result of a value-added tax rise from 15% to 18% to achieve the revenue targets stipulated by the IMF.

IMF’s aspiring goals to enhance public finances, inclusive of an 18% spike in power costs from October, have also placed additional pressure on inflation.

Future Projections

“Inflation rates by the end of January are predicted to be just under 5%, despite the surge in taxes”, stated Dimantha Mathew, Head of Research at First Capital Research. He continued, “a low demand will continue to suppress prices”.

Overall, “last year’s high base effect will ensure that any inflation spikes will be short-lived”.

The CBSL is expected to keep its monetary policy rates steady on Tuesday to regulate inflation. This comes after a 650-basis-point reduction in interest rates since the commencement of its easing cycle in June 2023, implemented to promote economic recovery from the previous year’s recession.

Any significant changes in inflation and economic policies can directly impact foreign exchange rates and trading activities. Subsequently, investors and traders dealing with assets related to Sri Lanka’s economy should closely observe these developments.

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