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Sri Lanka inflation rate: Will Asia's fastest price rises drive the country further into recession?

By Fitri Wulandari

Edited by Georgy Istigechev

17:55, 2 January 2023

Anti-Government protesters gathering stage a protest in Colombo against the government of Sri Lanka
Sri Lanka's widely watched Colombo Consumer Price Index (CCPI) fell to 57.2% year-on-year in December – Photo: Ruwan Walpola / Shutterstock.com

According to the most recent data, Sri Lanka's inflation rate eased slightly at the end of 2022.

Based on official figures, headline inflation in the debt-ridden South Asian country was 65% in November, compared to a peak of 73.7% in September 2022. The widely watched Colombo Consumer Price Index (CCPI) also fell to 57.2% year-on-year (YoY) in December from 69.8% in September.

While the easing inflation rate may provide some relief, it raises concerns about whether the downtrend will continue.

Facing severe economic and political crises, Sri Lanka is pushing to secure a final approval from the International Monetary Fund (IMF) for the disbursement of the $2.9bn bailout package agreed upon in September 2022. The loan is crucial for shoring up the country’s depleting foreign exchange reserves, which have contributed to the sharp depreciation of the national currency, the Sri Lankan Rupee (LKR), and supply shortages.

Under the agreement, Sri Lanka must first reach a debt relief deal with its creditors and multiple financing partners before the bailout package can be disbursed.

As it is still unclear when Sri Lanka is going to receive an IMF loan, what will be the outlook for Sri Lanka’s inflation rate in 2023 and beyond?

How is the inflation rate measured in Sri Lanka?

Prices for goods and services fluctuate constantly. Because of changes in supply and demand, the prices of certain goods and services can fall while others rise. Inflation is defined as a general increase in the price of goods and services that does not affect only a few items or services.

When the price of goods and services rises, the money used to buy them loses value. The rate at which money loses its purchasing power in terms of goods and services is referred to as the inflation rate.

In Sri Lanka, the Department of Census and Statistics calculates the National Consumer Price Index (NCPI) by collecting prices from all nine provinces in the country.

The NCPI basket contains 105 subcategories of goods and services divided into 12 groups. Food makes up 44.04% of the NCPI, while non-food items constitute 55.96%.

The non-food items are as follows:

  1. Alcoholic beverages, tobacco, and narcotics
  2. Clothing and footwear
  3. Housing, water, electricity, and fuel
  4. Furnishing, household equipment, and routine household maintenance
  5. Health
  6. Transport
  7. Communication
  8. Recreation and culture
  9. Education
  10. Restaurant and hotels
  11. Miscellaneous goods and services


Another key inflation indicator in Sri Lanka is the Colombo Consumer Price Index (CCPI), which measures changes in the prices of goods and services in the country's capital, Colombo.

Sri Lanka's inflation rate history

Sri Lanka's inflation rate history from the Department of Census and Statistics indicates that monthly price increases in the country were largely low over the course of 2020 up until Q3 2021, hovering between as low as 3.10% to 8.10%.

Inflation rates began to climb in November 2021, with the NCPI rising at an annual rate of 11.10% and the CCPI accelerating by 9.9% YoY.

Sri Lanka Inflation Rate (2012-2022)

By January 2022, NCPI had quickened to 16.8% and CCPI stood at 14.20%, mainly due to the depreciating rupee against the US dollar which had strengthened by aggressive US interest rate hikes and soaring global commodity prices – particularly those of oil and gas – triggered by the Russia and Ukraine war. Oil is Sri Lanka’s main commodity import.

The US dollar/Sri Lankan rupee (USD/LKR) currency pair had increased 75% to 356 by the end of the first half of 2022, from 202 at the start of the year. The falling rupee against the US dollar increased the cost of servicing foreign-exchange debt and pushed inflation to record-breaking levels.

The NCPI and CCPI advanced at annual rates of 58.90% and 54.60%, respectively, in June 2022, worsening the country's economy and sparking nationwide protests as Sri Lankans struggled with fuel, food, and medicine shortages. The protests were instrumental in the removal of the powerful President Gotabaya Rajapaksa.

Rajapaksa was replaced by prime minister Ranil Wickremesinghe in July, but inflation did not show signs of abating. In September, CCPI rose 69.8% and NCPI advanced 73.7% before gradually easing in October and November.

Food inflation has remained a major contributor to the soaring Sri Lanka inflation rate as high commodity prices caused by the Russia-Ukraine war, exacerbated the increase in domestic food prices.

To cool the red-hot inflation, the Central Bank of Sri Lanka has increased the policy rates to 14.5% for the Standing Deposit Facility Rate (SDFR) and 15.50% for the Standing Lending Facility Rate (SLFR) by November 2022, from 5.5% and 6.5% respectively in January 2022.

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What’s driving runaway inflation in Sri Lanka?

Soaring inflation in Sri Lanka was not built up overnight. It was a knock-on effect of past economic policies – according to the World Bank, a loose monetary policy, weak investment climate, and administered exchange rate all contributed to the problem.

We investigate the key drivers that have fuelled the eye-watering Sri Lanka inflation rate.

Shrinking foreign exchange reserves weakens the rupee

The Sri Lankan government has blamed the current macroeconomic crisis on the COVID-19 pandemic, which has reduced external revenue from the tourism sector – the country’s key economic driver, the World Bank in its report said signs of weakness had appeared before the pandemic.

For years, a lack of fiscal discipline and risky commercial borrowing had increased public debt to unsustainable levels. Sri Lanka drained its official reserves to service debt and facilitate imports after losing access to the international financial market in 2020 as a result of rating downgrades, according to the World Bank’s Sri Lanka Development Update in October last yaer.

With foreign exchange running low, the Central Bank of Sri Lanka (CBSL) was unable to shield the rupee when the US Federal Reserve’s hawkish tightening cycle bolstered the greenback. This has sped the collapse of the Sri Lankan rupee.

At the end of November 2022, the country’s official reserves stood at an estimated $1.806bn, which plummeted from $7.52bn at the end of November 2019, according to CBSL data.

Because of the depletion of foreign exchange liquidity, Sri Lanka has struggled to import necessities such as fuel, food, cooking gas, and medicine. As a result, power outages are frequent, and food shortages are widespread.

According to the CBSL’s weekly report, the Sri Lankan rupee depreciated against the US dollar by 44.8% over 2022 as of 30 December and weakened against the Euro by 41.4%. As of 2 January, the USD/LKR pair gained 80.27% YoY.

Fertiliser ban hurt domestic food production

Analysts also attributed Sri Lanka’s current economic doom to the ill-fated decision by President Rajapaksa to ban imports of chemical fertiliser in April 2021. The ban aimed to boost organic farming and reduce the adverse impact of chemical fertilisers, such as lake and groundwater pollution.

Although the ban was lifted in November 2021, the ban has broader repercussions on the country's economy. Food crop yields fell as chemical fertilisers remained scarce due to a lack of foreign exchange which subsequently reduced agriculture productivity and related manufacturing sectors, according to the World Bank.

“The ban on agrochemicals impacted domestic food prices through reduced productivity and increased cost of fertiliser in the informal market,” the institution stated.

According to the World Bank, an assessment by various stakeholders predicted the yield of major crops, such as paddy, vegetables, and other food crops to drop by 20-50% in 2022.

The economy contracted by 4.8% in the first six months of 2022, as the fertiliser ban caused large contractions in the agriculture and industry sectors, particularly in food and beverage manufacturing.

Sri Lanka Inflation forecasts: 2023 and beyond

As the inflation rate edged down in the last months of 2022, what will be Sri Lanka's expected inflation in 2023 and beyond?

The Asian Development Bank (ADB) expected Sri Lanka’s inflation rate in 2023 to ease to 18.6% from 44.8% in 2022.

According to the World Bank’s October 2022 report, the inflation rate in Sri Lanka was projected to decelerate to 23.8% and to slow further to 8% in 2024 from an estimated 45.8% in 2022. In its Sri Lanka inflation rate forecast, the institution said:

“Despite the expected further tightening of monetary policy, inflation will likely stay elevated in 2023 due to currency depreciation, high global commodity prices and continued monetization of the fiscal deficit."

Without giving Sri Lanka's inflation forecast in detail, the Central Bank of Sri Lanka said in its Economic Performance and Outlook for 2023:

“Headline inflation is expected to moderate in the period ahead with the potential softening of domestic commodity prices in the wake of downward revisions to administratively determined prices of certain commodities in line with global developments, improved domestic supply conditions in relation to agriculture and subdued aggregate demand pressures resulting from tight monetary and fiscal conditions, and the favourable statistical base effect.”

When looking at Sri Lanka's inflation predictions, keep in mind that analyst forecasts are not always correct. You should always do your research by reading the latest news, conducting technical and fundamental analyses, studying a wide range of commentary on the Sri Lankan economy, and monitoring official data releases.

It is important to note that your decision to trade should be based on your risk tolerance, market knowledge, portfolio spread, and how comfortable you are with losing money. Never trade more than you can afford to lose.

FAQs

What is the current inflation rate in Sri Lanka?

The headline inflation based on the National Consumer Price Index (NCPI) stood at an annual rate of 65% in November. The inflation rate in the country’s capital, Colombo, rose by 57.2% in December.

Has inflation been going up or down in Sri Lanka?

Inflation has been steadily going up in Sri Lanka. The country’s key inflation rate eased for the third consecutive month to 57.2% in December 2022, the lowest since June, compared to 61% in November, as tight monetary policy pressured demand and supply conditions stabilized.

Why is inflation so high right now?

Sri Lanka's inflation rate is high due to the sharp depreciation of the rupee and rising local food prices, as the country's fertiliser import ban has reduced food crop output.

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