Wednesday, October 20, 2010

Policy rates steady

The rates at which commercial banks borrow overnight from the Central Bank and deposit their excess rupees have not been changed by the Central Bank and therefore the reverse repurchase rate and repurchase rate would remain at 9 percent and 7.25 percent.

"Economic growth remains robust and broad based with all sectors contributing to the expansion of output. Credit flows continue to rebound with credit to the private sector from commercial banks growing on a year on year basis by 12.8 per cent in August 2010, further reinforcing the growth prospects. At the same time, year on year growth in broad money remains moderate at 13.9 per cent in August," the Central Bank said issuing its Monetary Policy review for October.

"The successful issue of the 10-year international sovereign bond on 27 September at a comparatively lower coupon rate of 6.25 per cent and attracting an order book of more than 6 times the value of the bond reflects the improved investor confidence in the economy. Gross international reserves further increased with the receipt of the fifth tranche of the IMF-SBA facility and the proceeds of the international sovereign bond," it said. Reserves are estimated to be above US$ 7 billion.

"Inflation, as measured by the year on year change in the Colombo Consumers’ Price Index (2002=100) increased in September to 5.8 per cent from 5 per cent in August. However, inflation is expected to remain subdued over the coming months," the Central Bank said adding that expected developments in the economy led to the decision to maintain policy interest rates as they were.

Banks have been cautious in there lending and economists, the Central Bank and International Monetary Fund were concerned that private sector credit growth was not adequate enough to maintain growth at 7.5 to 8 percent. Foreign direct investment too have declined during the first six months of this year, falling 17.66 percent to US$ 208.05 million from the corresponding period of 2009, a time when the sting of the global financial crisis was stronger and the last stages of the conflict were being fought.

Despite the Central Bank lowering policy rates so as to boost private sector credit growth, banks were cautious, but for months these banks have been forcing another downward revision by bidding down Treasury bill rates (benchmark rates) at the weekly auctions and for weeks the rate on the twelve month bill was lower than the overnight repurchase rate.

But for the past two weeks, banks seemed to show a change of heart when they bid rates up, although marginally. Dealers said this because they expected inflation to rise, while some dealers warned that this inflation expectation could actually drive rates upwards rather than real inflation. At the time of writing, the results of the Treasury bill auction was not released.

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