October 2, 2018 / 3:05 AM / 2 months ago

UPDATE 2-Sri Lanka surprises, keeps rates steady despite pressure on rupee

* Cenbank says measures taken will ease pressure on rupee

* Growth in remaining quarters will be higher than H1 2018

* Rupee down around 10 pct this year amid foreign bond outflows

* GDP growth picked up in Q2, had hit a 16-yr low in 2017

* (Adds cenbank governor, analyst comment)

By Shihar Aneez and Ranga Sirilal

COLOMBO, Oct 2 (Reuters) - Sri Lanka’s central bank surprised financial markets on Tuesday by leaving its key policy rates unchanged, despite heavy pressure on the rupee currency and foreign outflows from government securities.

Policymakers have struggled to defend the fragile rupee, which fell 4.7 percent last month in the face of a strong dollar and outflows from emerging markets amid rising U.S. interest rates.

Sri Lanka has already imposed a raft of measures to restrict imports with immediate effect to try to take pressure off the rupee, which is hovering at a record low.

“These measures are expected to ease the excessive demand for foreign currency and hence the pressure in the domestic foreign exchange market as already observed in the stabilising exchange rate,” the central bank said in its statement.

The central bank kept the standing lending facility rate (SLFR) at 8.50 percent and standing deposit facility rate (SDFR) at 7.25 percent. The market had expected hikes for both.

Central Bank Governor Indrajit Coomaraswamy said the decision to keep rates steady was taken as a raise would not stop foreigners from withdrawing their funds or attract new foreign investors into government funds.

Fitch Solutions in a report said it expected the central bank to keep its monetary policy stance on hold for the rest of 2018 and 2019.

“We believe that a rate hike is unlikely as the central bank will seek to keep interest rates accommodative amid still-weak economic growth and moderate inflation.”

Sri Lanka’s key rates have been unchanged since April, when there was a surprise cut in SDFR.

A strengthening dollar since mid-April has increased the credit risks in some emerging markets, including Sri Lanka, due to currency depreciation, ratings agency Moody’s said in June.

Sri Lanka has seen net outflows of 72.5 billion rupees ($429 million) so far this year through Sept. 26 from foreign investors selling government bonds, central bank data showed.

Tuesday’s rate announcement comes as some investors are worried about a slowing economy and increases in fiscal spending ahead of presidential elections next year and possible provincial council polls early in 2019.

The International Monetary Fund (IMF) on Friday revised down its projection for 2018 Sri Lankan economic growth to under 4 percent, from June’s forecast of 4 percent.

“I think they (the central bank) are more worried about growth. Keeping rates stable may not be the best scenario for rupee stability,” said Danushka Samarasinghe, research head at Softlogic Stockbrokers.

“My worry would be whether it will be too late (to raise rates) in the case of U.S. continuing to increase rates and global markets interest rates continue to rise.”

He said markets are now waiting to see if the monetary authority will allow market rates to move up despite keeping the policy rates unchanged.

Sri Lanka’s economic growth cooled to a 16-year low of 3.3 percent last year due to tight monetary and fiscal conditions, droughts and floods.

But the central bank said economic growth in the second half of the year will be better than the first six months, based on current developments and projections.

Annual growth in the second quarter was 3.7 percent.

Credit growth has been slowing. In August, the annual pace was 14.3 percent, compared with 28.5 percent in July, 2016.

Reporting by Shihar Aneez and Ranga Sirilal; Editing by Kim Coghill and Vyas Mohan

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