(Adds details, analysts’ comments & context)
By Shihar Aneez and Ranga Sirilal
COLOMBO, May 11 (Reuters) - Sri Lanka’s central bank kept its key policy rates steady on Friday, a little more than a month after it unexpectedly cut the main lending rate, forecasting a modest recovery in the economy this year after growth slumped to a 16-year low in 2017.
The central bank’s widely expected decision comes amid worries about political instability after the ruling coalition lost a local government election earlier this year, leading to the defection of 16 of its members to the opposition.
The central bank left the standing lending facility rate (SLFR) at 8.50 percent and standing deposit facility rate (SDFR) at 7.25 percent, saying it “aims at stabilising inflation in mid-single digit levels in the medium term.”
The bank estimated 2018 growth to be around 5 percent, higher than the International Monetary Fund’s (IMF) 4 percent forecast.
In its policy statement, the central bank predicted a “moderate” economic recovery this year, thanks to strengthening global growth and improving domestic conditions.
“Forward looking indicators suggest an improvement in the economic performance on the back of the modest recovery in the agriculture sector and continued positive momentum in the industry and services sectors,” the statement said.
Growth slipped to a 16-year low in 2017, hit by widespread flooding and a pullback in foreign investment. Worries of political instability have lately cast a cloud on the outlook.
President Maithripala Sirisena suspended the parliament last month, reconvening it only this week, underscoring investor uncertainty about broad policymaking and economic management.
Danushka Samarasinghe, research head at Softlogic Stockbrokers, said the central bank would be averse to cutting rates again because of the pressure on the rupee currency.
Still, Capital Economics analysts said in a note that they expect a further easing later this year, citing benign inflation and an economic recovery that is “likely to disappoint.”
The IMF in March urged the central bank to stand ready to tighten if signs of demand-side inflation pressures or accelerating credit growth resurface.
Credit growth picked up to 15.3 percent year-on-year in March, from February’s 14.6 percent, but was well off a near four-year high of 28.5 percent hit in July 2016.
The central bank, which in April said it has shifted away from a tightening bias, expects inflation to remain in the bottom half of a 4-6 percent band through the rest of this year.
The previous rate hikes through December 2015 to March 2017, aimed at curbing high inflation and fending off pressure on the fragile rupee, weighed on the economy. As well, tight fiscal measures to meet conditions by the International Monetary Fund (IMF) for a $1.5 billion loan further sapped demand.
The rupee is hovering near record lows as investors worried that policy paralysis in the wake of the February election upset could hurt foreign investment - a crucial prop for the economy.
It slipped to a record-low of 157.90 on May 2 and closed at the same level on Thursday. The currency market is yet to start trading on Friday.
Reporting by Shihar Aneez and Ranga Sirilal Editing by Shri Navaratnam