By Uditha Jayasinghe

COLOMBO The Central Bank of Sri Lanka has cut the statutory reserve ratio for commercial banks by 200 basis points to 2%, effective Aug. 16, it said on Wednesday.

The decision was taken to inject liquidity into the banking system and further reduce the market liquidity deficit on a permanent basis, the bank said in a statement.

The move is expected to inject about 200 billion rupees ($625 million) into the domestic money market and further reduce interest rates, it said.

"This was very unexpected but the central bank has been expressing slowness in the decline of interest rates. This measure will address that," said Dimantha Mathew, head of research, First Capital.

Encouraged by a steep drop in inflation, which hit 6.3% last month, the central bank cut policy rates by 450 basis points in June and July.

Yield rates on government securities, currently at 13%-14%, are expected to drop to 11% for one year and 12%-13% for longer term five- and ten-year bonds, analysts said.

Cheaper lending rates will also boost sluggish growth.

"The central bank was also under pressure with the slowness of economic recovery, so this addresses the growth issue rather than anything else," Mathew added.

Sri Lanka's economy contracted by 7.8% last year and is expected to shrink 2% in 2023.

The monetary authority had earlier warned it would also take administrative steps to push down interest rates if commercial banks were slow to pass on the rate cut to the market but has not given a timeline.

The central bank raised rates by a record 950 bps last year to tame surging inflation and by 100 bps on March 3 as the country battled its worst financial crisis in decades.

(Reporting by Chris Thomas in Bengaluru; Editing by Raju Gopalakrishnan and Bernadette Baum)