Sri Lanka - Rates

• Policy rates down, dealers expect private sector credit to pick up

• GDP growth to be enhanced, budget deficit contained

By Devan Daniel

The Monetary Board of the Central Bank has brought down policy rates by 0.25 percent and revised annual average growth rates on reserve money to 21.2 percent from an earlier target of 14.5 percent, in a move bank dealers anticipated that would facilitate private sector credit growth and enhance GDP growth.

The Monetary Board has reduced the repurchase and reverse repurchase rates by 0.25 percent each to 7.25 percent and 9.5 percent respectively. The repurchase rate is the rate at which commercial banks deposit excess funds with the Central Bank, while the reverse repurchase rates apply to overnight borrowings of the banking system from the Central Bank.

"We were expecting this reduction to policy rates even though some analysts had been concerned about rising inflation. When policy rates come down, Treasury bill rates and bank rates come down and this would help the government bring down the budget deficit as interest costs come down," a commercial bank dealer said speaking to The Island.

"This would also enhance GDP growth as the private sector gains access to cheaper credit. This would also give foreign investors a positive sign that Sri Lanka’s economy is poised to expand," he said.

Some analysts said market rates could come down by 1 percent because of the policy rate cuts.

However, dealers said it was too much of a reduction. "We need to watch the open market operations of the Central Bank (where Treasury bills or Central Bank securities are auctioned to clear excessive inflationary liquidity in the banking system)."

"With excess liquidity ranging between Rs. 20 to 30 billion, the Central Bank has been sterilising access liquidity in the system and open market operations would determine by how much market rates adjust downwards," a dealer said.

Last week, the average weighted prime lending rate (for high net worth individuals and corporates) was 10.37 percent which was 15.54 percent a year ago.

The three month Treasury bill rate was 8.07 percent, six months 8.93 percent and one year 9.29 percent. A year ago these rates were 11.41 percent, 12.03 percent and 12.34 percent respectively.

Dealers also said they expected the 7.25 percent and 9.50 percent rates to remain unchanged well into 2011.

In a statement announcing the policy rate cuts the Central Bank observed the following developments in the economy: "Inflation continued to decline, for the fourth consecutive month, reaching 4.8 per cent in June 2010, while annual average inflation reached 3.9 per cent in June. Going forward, inflation is expected to remain subdued, at single digit levels, during the remainder of the year.

Growth in broad money (liquid currency in circulation, including demand deposits) continued to moderate during the first five months of the year. By end May 2010, the year-on-year growth in the broad money supply was 15.5 per cent compared to 18.6 per cent at year end 2009.

Credit flows to the private sector have been increasing since the latter part of 2009, and reached a year-on-year growth of 3.5 per cent by end May in contrast to a contraction of 5.7 per cent at year end 2009. Credit to the private sector needs to continue to expand in the coming months as economic growth picks up.

External trade also showed strong signs of recovery during the first four months of the year with exports increasing by 10.7 per cent and non-oil imports increasing by 29 per cent. The gross official reserves of the country including forex swaps were further enhanced by the receipt of two tranches of the IMF-SBA Facility to approximately US dollars 5.7 billion, as at 30 June 2010, which is equivalent to 6 months of imports.

GDP growth in the first quarter of 2010 has been estimated at 7.1 per cent and the economy is expected to expand by around 7 per cent during the year. Taking into consideration these developments in the economy the Monetary Board has decided to revise the policy interest rates downward. In response to this, lending rates of commercial banks are expected to adjust further downward, stimulating economic activity," the Central Bank said.

In line with the expected increase in credit, the Monetary Board also adjusted the annual average Reserve Money (cash held with the public and demand deposits with banks) target to Rs. 334 billion, a 21.2 percent growth from the previous year. The original target was a growth rate of 14.5 percent at Rs. 315.5 billion.

source - www.island.lk