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INTERVIEW-UPDATE 2-Sri Lanka's inflation may fall under 10 pct
(Recast, adds bylines, details, quotes)
By Shihar Aneez and C. Bryson Hull
COLOMBO Aug 28 (Reuters) - Sri Lanka's economic growth is expected to be less than a forecast 7 percent this year due to tight monetary conditions but inflation may fall into single digits by the end of 2009, the central bank governor said.
All-time high fuel and food prices pushed inflation in Sri Lanka this year -- among the highest in Asia -- to a record level when measured on an index introduced in December that tracks it back to 2002. Under the old index, it would be an 18-year high.
"If there are no major shocks, we would see a single digit inflation by end of next year," Central Bank Governor Ajith Nivard Cabraal told Reuters in an interview on Thursday.
But he warned that tight monetary policy would mean growth in 2008 would be slightly less than the forecast 7 percent.
"It would be lower than 7 percent. But nevertheless it wouldn't have been much more. If we can manage the growth between 6-7 percent and also if we can bring down the inflation, then we can withstand a very tough trend."
Sri Lanka's economy expanded 6.8 percent in 2007.
Cabraal said targeting reserve money numbers on a daily basis should prompt inflation to ease "faster than any other country (in South Asia) if you see the numbers in the next 6-12 months".
He predicted that annual inflation by December should drop to around 20 percent, down from a peak of 28.2 percent in June. In July, consumer price inflation was at 26.6 percent.
The central bank has left its monetary policy rates unchanged for the past 18 months after deciding it was not effective enough to control accelerating inflation.
Instead, it has opted since mid-2007 to focus on reserve money targets to reduce excess market liquidity.
Many analysts and stock market players have complained that the lack of a rate change has hampered investment on the Colombo Stock Exchange .CES and kept the rates artificially low.
But earlier this month, analysts said the reserve money policy had begun to show benefits despite the fact that investors have been discouraged from buying shares on the bourse in the absence of any new direction on rates.
HIGH GOVERNMENT SPENDING
The International Monetary Fund and the Asian Development Bank have criticised the government's public expenditure, which last year amounted to 85.8 percent of $27 billion GDP.
The cost of a 25-year civil war with Tamil Tiger separatists has risen this year with a military offensive to rout the rebels from their northern stronghold. A high government wage bill and food subsidies have also kept public expenditure high.
"Although our debts have been rising, if your debt-to-GDP ratios are on the decline, that is a sound indication that you are at the right side of the borrowing," Cabraal said. "By end of 2008, we would come down to early 80s maybe 81-82 percent."
Sri Lanka's annual budget shortfall is also coming down.
"In year 2000, the fiscal deficit was as high as 10 percent. Last year it came down to 7.7 percent," Cabraal said. "This year we will be closer to 7 percent. The target is 7 percent. We could probably reach 7.1 percent."
Increasing external commercial finance, a criticism leveled against the government by rating agencies and analysts, is inevitable due to the country's rise to middle-income status, Cabraal said.
"In the next 3-4 years, the borrowing would be $2 billion per annum from external financing. Of this, $500 million is going to be from commercial sources like bond issue or syndicated loan."
Cabraal said the central bank would continue to intervene in currency markets to smooth short-term fluctuations, but rejected criticism it does so to keep the rupee artificially stable.
"Our net absorption during the course of 2008 is as high as $350 million, which means through our policy of absorption, we have not allowed the rupee to appreciate," he said.
The rupee's level will be determined by market forces over time, he said. "If it is a temporary fluctuation, we will intervene. But if it is a permanent one we will let the permanent situation take place in a controlled manner."
The rupee LKR= closed at 107.78/81 on Wednesday against the dollar and this year has risen around 1 percent. (Writing by Bryson Hull; Editing by Jacqueline Wong)
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