September 26, 2017 / 12:18 PM / a year ago

UPDATE 2-Sri Lanka's central bank keeps rates steady to spur growth

* Weak external demand, extreme weather affect growth

* Credit growth slows to 18 pct in August

* Analysts expect GDP growth to remain subdued

* Cenbank expects inflation to slow by end 2017 (Adds cenbank chief comments)

By Shihar Aneez and Ranga Sirilal

COLOMBO, Sept 26 (Reuters) - Sri Lanka’s central bank held its key rates steady on Tuesday, saying past steps were keeping inflation and credit growth under control, as policymakers focus on supporting an economy hit by extreme weather.

As widely expected, the central bank kept the standing deposit facility rate (SDFR) at 7.25 percent and standing lending facility rate (SLFR) at 8.75 percent - both are now at over a four-year high.

“Economic growth continued to be affected by extreme weather conditions and weak external demand,” the central bank said in its policy statement.

“Although disruptions to near term growth prospects continue, forward looking indicators show improved medium term prospects, which are likely to be realised with the envisaged structural reforms and expected inflows of foreign investments.”

Analysts say the central bank is now focusing more on GDP growth than on credit expansion as economic momentum is expected to weaken further due to bad weather - the most severe drought in 40 years in the first quarter and the worst flooding in 14 years.

Treasury bill rates have fallen by between 86 and 201 basis points since April, mainly driven by foreign buying, which could be good for the economy but may also add to inflationary pressures.

Central Bank Governor Indrajit Coomaraswamy, however, said the reduction in the t-bill yields have yet to reflect in market lending rates.

“When that happens and if it leads to what the monetary board thinks is unsustainable credit growth then clearly action would be needed to be taken. Then we will tighten the monetary policy but we haven’t got there,” he told reporters.

The previous four rate increases since December 2015 have dragged on the $81 billion economy, which grew at an annual pace of 4.0 percent in the quarter ended June 2017, nudging up from 3.8 percent in the previous quarter. Tight fiscal policy has also crimped growth.

Analysts expect 2017 growth will significantly undershoot the central bank’s forecast of between 4.5 percent and 5 percent, although Prime Minister Ranil Wickremesinghe has predicted up to 5 percent growth for the year.

“With fiscal policy set to be tightened over the coming year and the impact of recent interest rate hikes still filtering through, the economy is likely to remain subdued,” Gareth Leather, senior Asia economist at Capital Economics said in a market note.

“We are forecasting GDP growth of just 4 percent over the next couple of years.”

The central bank’s previous tightening steps, which were partly aimed at fending off pressure on the fragile rupee , have had some impact on loans growth. Annual private sector credit growth of 18.0 percent in August was well off a near four-year high of 28.5 percent hit in July 2016.

Consumer inflation, however, was up 6 percent in August from a year earlier, accelerating from the previous month’s 4.8 percent.

The central bank expects inflation to ease by year-end.

“Projections indicate that inflation will revert to the envisaged mid-single digit levels by end 2017 and stabilise thereafter, underpinned by tight monetary conditions that have been in place from the beginning of 2016,” the bank said. (Reporting by Shihar Aneez; Editing by Shri Navaratnam and Biju Dwarakanath)

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