We are confident that if the fiscal situation is contained, the direction of interest rates will be downwards

A.G. Karunasena Central Bank of Sri Lanka

And the bank added that a ceasefire signed by government forces and Tamil separatists in February could provide the economy with a further fillip.

"There could be additional gains (in growth) depending on the peace process," said Central Bank Deputy Governor W.A. Wijewardena.

"In the next few years there could be between three to four percent of additional growth if there is full peace," he said.

Monetary easing

Inflation is expected to fall to 9% this year from 14.2% in 2001, and the bank signalled it may cut interest rates from their current level of 12%.

"We are confident that if the fiscal situation is contained, the direction of interest rates will be downwards," said A.G. Karunasena, director for economic research at the central bank.

"It all depends on the supply and demand for funds and if the public sector can maintain its targets," he said.

The government has promised to cut its budget deficit to 8.5% of gross domestic product in 2002.

State-owned firms, which are not funded from the budget, have also pledged to cut spending.

State-owned companies such as the country's sole oil refiner Ceylon Petroleum Corporation and the Ceylon Electricity Board reported big losses last year, and borrowed heavily from the country's shaky banking sector.

Currency stable

Interest rates soared early last year, partly because of a foreign reserve crisis after the rupee floated in January.

Mr Karunasena said the currency had stabilised after initial jitters.

"The real effective exchange rate appreciated by about 2%. We are not targeting a particular rate this year," he said.

The rupee depreciated by more than 11% against the dollar last year.

The government and the separatist Tamil Tigers signed a permanent ceasefire in February, ending 19 years of bloody civil war which killed 64,000 people and devastated the economy.