If Sai Baba already knew what was in Damu Anna's letter, why did he make Shama read it out loud? He even says 'Why do you think my words are the truth?' which sounds like he's admitting he doesn't know.

This is a subtle point described in the narrative. While Sai Baba demonstrated his prescience by stating the essence of the letter before it was read, he playfully feigned ignorance. In Chapter 25, Shama points out this very paradox, saying, "You already know the inner intent, then why do You have it read?" Baba's response, "Arre Shama, read it, read it! Why do you think my words are the truth? I am just as I am. I just speak whatever comes to my mind," appears to be a display of his humility and a way to engage his devotees in a divine play. By having the letter read, the situation unfolded for all present, and the subsequent advice was given openly after the formal request was officially heard.