By Uditha Jayasinghe and Krishna N. Das
COLOMBO (Reuters) -Sri Lanka’s central bank has room to cut interest rates further but is treading carefully to preserve a buffer against potential external shocks, Governor P. Nandalal Weerasinghe told Reuters on Friday, ahead of its policy meeting on September 23.
The Central Bank of Sri Lanka surprised markets in May by trimming its overnight policy rate by 25 basis points to 7.75%, a move Weerasinghe said had “nicely transmitted into the marketplace” with “very stable structures.”
“If we think we need to support the economy short term, in terms of kind of closing the output gap, then we have space here, but I think we have to be a bit cautious in our approach,” said Weerasinghe, who became central bank governor in 2022 during the peak of Sri Lanka’s worst economic crisis in decades.
“We need to maintain key buffers in case there are any external shocks, we should be able to use that buffer if that is needed in the future.”
Sri Lanka’s economy contracted sharply in 2022 and 2023, hit by a sovereign debt default, runaway inflation and acute shortages of fuel, food and medicine. The crisis triggered mass protests and political upheaval, forcing the government to seek a bailout from the International Monetary Fund.
Since then, the country has made significant progress in stabilising its macroeconomic fundamentals. Inflation has eased, foreign reserves have improved and the rupee has strengthened, allowing the central bank to gradually shift from crisis management to a more balanced monetary stance.
In an interview at his office in Colombo overlooking the Indian Ocean, Weerasinghe said monetary policy can offer short-term support but is not a sustainable driver of growth.
“The central bank, by providing credit or loosening too much monetary policy, cannot support the boost of growth. It can happen in the short term, but it won’t sustain long term,” he said.
“Right now, it’s a balanced monetary policy,” he added. “Whether we’re loosening or tightening, we’ll certainly be on a forward-looking and data-driven basis.”
Weerasinghe emphasised that fiscal sustainability and structural reforms, not monetary easing, are key to achieving GDP growth of around 5%, which is the central bank’s target and was last year’s growth rate. He pointed to foreign direct investment, support for small and medium-sized enterprises, tourism and export competitiveness as critical levers for growth.
The policy decision on September 23 will incorporate the latest data on inflation, output, and external balances. “We make a decision based on how indicators are moving forward,” he said, adding that the bank’s current stance is “the right position”.
FOCUS ON RESERVES
The central bank is now focused on maintaining a comfortable level of foreign reserves to meet external debt obligations, a key lesson from the 2022 crisis. Weerasinghe said that prior to the crisis, the country faced annual debt servicing needs of $6 billion with only $8 billion in reserves, an unsustainable position that worsened as reserves depleted to zero.
Looking ahead, Sri Lanka’s average annual external obligations are expected to be around $3.5 billion to $4 billion over the next decade. If reserves can be maintained at $8 billion or more, the country would be in a far more stable and resilient position than during the crisis years. Current reserves are at $6.2 billion.
The country of 20 million is growing faster than needed to maintain economic sustainability, he said, citing recent growth rates of nearly 5% — well above the IMF’s baseline requirement of 3% for medium-term stability.
This stronger-than-expected recovery suggests the country could reach a more stable and sustainable economic footing faster than previously projected. If growth continues in the 3–5% range, Sri Lanka could improve living standards and macroeconomic resilience over the next 5–10 years, he said.
Weerasinghe added that current indicators show the economy is recovering steadily, and the outlook remains positive.
“You need to have steady, sustainable growth. You can earn something higher short term, it’s not sustainable.”
(Reporting by Uditha Jayasinghe and Krishna N. Das in Colombo; Editing by Susan Fenton)
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