By: Isuru Parakrama
October 10, Colombo (LNW): The Central Bank of Sri Lanka (CBSL) has defended its decision to maintain a 5 per cent inflation target until October 2029, arguing that a more aggressive effort to suppress price increases could undermine economic growth and leave the country worse off in the long run.
The position has sparked debate among economists and monetary policy analysts, some of whom believe Sri Lanka should adopt a lower target of 2 per cent to protect household purchasing power, strengthen the rupee and establish greater stability in the economy.
The CBSL has recommended the 5 per cent target to the Government under a three-year agreement, maintaining that the chosen level represents a balance between controlling inflation and allowing economic activity to expand.
CBSL Governor Dr Nandalal Weerasinghe explained the reasoning during a panel discussion with senior officials, arguing that the appropriate inflation target depends on a country’s economic circumstances, growth potential and capacity to expand production.
Although a lower inflation rate may appear beneficial from the perspective of consumers, he cautioned that setting the target too low could restrict economic activity and prevent the country from achieving its full growth potential.
Weerasinghe maintained that the 5 per cent benchmark had been selected following extensive research and consideration of alternative scenarios. He argued that a policy which delivers lower inflation at the expense of economic growth would not necessarily improve overall public welfare.
The Governor also indicated that the CBSL remained open to reconsidering the target in the future. Any adjustment, however, would depend on economic evidence and changing conditions rather than a predetermined commitment to a lower figure.
Critics of the policy argue that maintaining inflation at 5 per cent allows the general price level to rise substantially over time, placing additional pressure on households whose earnings may not increase at the same pace.
At a steady annual inflation rate of 5 per cent, prices would rise by approximately 15.8 per cent over three years, assuming the rate remains constant. Supporters of a 2 per cent target contend that keeping price increases closer to this level would help preserve purchasing power, particularly among lower- and middle-income families still recovering from Sri Lanka’s recent economic crisis.
They also argue that a lower inflation target could help address the country’s longstanding currency difficulties.
When domestic inflation consistently exceeds that of major trading partners, the resulting difference can contribute to pressure on the exchange rate over time, although currency movements also depend on factors such as productivity, capital flows, interest rates and external trade.
Proponents of a 2 per cent target say bringing Sri Lanka’s inflation objective closer to those of advanced economies could strengthen confidence in monetary policy, help anchor expectations about future prices and reduce the risk of recurring external imbalances.
Borrowing costs represent another area of disagreement. Analysts advocating a lower target believe that a more credible commitment to price stability could reduce the inflation premium demanded by lenders and investors, potentially lowering financing costs for businesses and the Government.
Under the existing framework, inflation is assessed against a 5 per cent target with a tolerance margin of two percentage points on either side. This places the acceptable range between 3 per cent and 7 per cent.
Critics argue that the relatively broad range creates uncertainty about future price movements, potentially encouraging lenders to demand higher returns to compensate for inflation risks. They believe a tighter target could provide a more predictable environment for long-term investment, although the effect on interest rates would also depend on other economic conditions and the credibility of monetary policy.
The debate comes as questions persist over the CBSL’s record in maintaining inflation within its prescribed range. Available figures indicate that the Bank missed its inflation targets in most quarters during the three-year period ending in September 2026.
The Bank has attributed periods of inflation falling below the lower boundary to declining energy prices, while increases in energy costs have contributed to inflation exceeding the upper limit on other occasions.
These fluctuations illustrate the difficulty of maintaining price stability in an economy exposed to external shocks, particularly changes in global commodity prices.
For the Central Bank, the challenge is to prevent temporary price movements from destabilising inflation expectations without imposing unnecessarily restrictive monetary conditions. For households, however, the distinction between a lower inflation rate and lower prices remains significant: even when inflation falls, the cost of living does not automatically return to previous levels.
The disagreement therefore centres on how Sri Lanka should balance immediate purchasing-power concerns with the longer-term objective of sustainable economic expansion.
While the CBSL maintains that 5 per cent offers the most appropriate balance under current conditions, advocates of a lower target argue that stronger price stability is essential to rebuilding confidence in the rupee and protecting living standards. The effectiveness of the existing framework will ultimately depend on whether it can deliver predictable inflation alongside sustained economic growth.
