The central bank’s recent policy report acknowledged that deflation was driven by one-off supply-side factors. It added that inflation is projected to align with the 5-7 per cent target range by the second half of the year due to diminishing supply-side effects and accommodative monetary policies.
Sri Lanka’s central bank has projected an increase in the cost of living, with inflation expected to rise to the 5-7 per cent target range in the latter half of 2025. This marks a shift from the deflationary trend observed since the second half of 2022, attributed to stringent monetary policies.
The central bank’s approach over the past two years allowed the Sri Lankan rupee to appreciate, leading to a reduction in prices across traded goods and energy — a rarity under International Monetary Fund (IMF) programmes. Analysts have noted that this deflationary period, achieved during a broader global “age of inflation,” is a significant achievement for Sri Lanka.
However, the central bank’s recent policy report acknowledged that deflation was driven by one-off supply-side factors. “The deflationary environment resulting from the one-off effects of supply-side price adjustments will continue in early 2025,” the report stated. It added that inflation is projected to align with the 5-7 per cent target range by the second half of the year due to diminishing supply-side effects and more accommodative monetary policies.
Deflationary Gains and Challenges Ahead
Deflationary policies implemented by the central bank have restored external stability and curtailed the cost of imported goods. Analysts have called it one of the institution’s most significant short-term achievements in its 75-year history. This period also coincided with a reversal of money printing by the US Federal Reserve starting in March 2022, which helped reduce global commodity prices.
The central bank’s policy shift aims to balance the benefits of deflation with the need for sustainable growth. “Following the high inflation episode from late 2021 to early 2023, it is believed that this temporary period of deflation would provide some respite to the general public by dampening the cost of living to some extent,” the report noted.
Historical Context and Global Lessons
Sri Lanka’s inflation management has drawn comparisons with global experiences during the Great Inflation of the 1970s. During that period, misconceptions about “supply-driven inflation” or “cost-push inflation” led to policy missteps in high-inflation countries. Classical economists argue that such beliefs, combined with unanchored monetary policies, were key contributors to prolonged inflationary episodes.
The US Federal Reserve’s recent 9 per cent inflation spike also stemmed from a mistaken belief in supply chain bottlenecks as the primary driver, rather than expansive monetary policies. Federal Reserve Chair Jerome Powell later admitted this was a miscalculation.
In contrast, Sri Lanka’s central bank embraced deflationary measures that allowed currency appreciation and restored external stability. Critics argue, however, that these gains may be short-lived without structural reforms and tighter inflation targets.
Inflation Targeting and Policy Transparency
Sri Lanka’s central bank operates under an inflation target of 5 per cent, with allowances to reach 7 per cent. These levels are higher than those in countries with greater monetary stability, where inflation targets typically range from 2 to 3 per cent. Critics contend that the central bank’s past policies, which aimed for 5 per cent inflation, contributed to recurrent currency crises in 2012, 2015, 2018, and 2020.
To ensure accountability, the central bank has committed to submitting regular reports to Parliament under the Central Bank of Sri Lanka Act. These reports aim to explain any deviations from the inflation target and maintain transparency. The first such report has already been submitted.
Looking Forward
The central bank’s projection of a 5-7 per cent inflation rate in late 2025 underscores the challenges of balancing price stability and growth in a post-deflationary environment. While deflation provided temporary relief to households, the return to inflation may strain budgets, especially in a country with a history of economic volatility.
Successive governments have attempted to address the rising cost of living through cabinet subcommittees, but analysts argue that a stricter inflation target would better control the monetary authority’s ability to influence prices. Without such measures, the central bank risks undermining public confidence in its policies.
The coming years will test Sri Lanka’s ability to sustain economic stability while navigating the complexities of inflation management. Policymakers face the dual challenge of preventing excessive price pressures and fostering conditions for long-term growth in a fragile economic landscape.
