Monetary policy rate cut, as expected

The Monetary Board of the Central Bank has cut the reverse repurchase rate by 50 basis points to 9 percent in a bid driving down commercial lending rates and compelling banks to increase their lending to the private sector. The reverse repurchase rate applies to overnight commercial bank borrowings from the Central Bank.

The Island Financial Review has been reporting for weeks that commercial bank dealers were expecting this to happen.

"The Central Bank has been reducing policy rates since the war ended in a bid to stimulating economic activity that would lead to job creations and growth. But if banks were slow in bringing down their rates it was because it took time to match the longer termed deposit rates which had been contracted at higher rates. Even when rates did come down, banks did not increase their lending to the private sector because of the high rates of defaults in 2007/08, which made banks very cautious in their lending," a dealer said.

The increased inflows of short term foreign investments have also increased the liquidity levels of banks due to conversions. Dealers say banks have been holding on to excess rupees amounting to Rs. 30 billion each day on average for the past three months. The Central Bank has been busy mopping up these rupees as too much money in the system could lead to inflation.

While being cautious in lending to the private sector, commercial banks have been investing in government securities, bringing down their rates further. There was high demand for long term securities even at single digit levels as dealers were confident rates would remain low as inflationary pressures in the economy was benign.

"We expected the Central Bank to bring down policy rates further in order to stimulate private sector credit growth, because this was the only option available to it. By bringing down the reverse repurchase rate the Central Bank was clear in its stance; it wants lending to the private sector to pick up," a dealer said.

According to latest data from the Central Bank, Credit to the private sector increased 6.2 percent to Rs. 1,268.9 billion in June from Rs. 1,195 billion a year ago. Loans from the domestic banking sector grew by 6.2 percent to Rs. 1,116.6 billion from Rs. 1,051.8 billion a year ago. Rs. 152.2 billion came from foreign sources. New loans in June amounted to Rs. 18.4 billion from the previous month.

Net credit to the government declined by 11.6 percent to Rs. 682.4 billion from Rs. 771.8 billion a year ago, largely on reduction on credit from the Central Bank which was Rs. 254.7 billion in June 2009, which has declined 57.4 percent to Rs. 108.6 billion.

However, domestic bank loans to the government increased by 19 percent to Rs. 474.9 billion from Rs. 399 billion a year ago while loans to public institutions increased 119 percent to Rs. 81.8 billion from Rs. 37.4 billion a year ago.

Dealers said they expected inflation to remain at low levels, which would allow the low interest rate environment to continue for at least another year.


source - www.island.lk