Sri Lanka central bank may cut floor rate in August

ECONOMYNEXT – Sri Lanka’s central bank which is propping up overnight rates a little above the 7.5 percent floor policy corridor with overnight liquidity withdrawals may cut the floor at the next policy meeting, Governor Indrajith Coomaraswamy said.

At the July 11 meeting the central bank kept the floor rate, which is now active, amid a private credit collapse that came in the wake of monetary instability in 2018, unchanged.

"It’s a wait and see policy the (rate setting) Monetary Board has taken," Governor Coomaraswamy told reporters in Colombo on Thursday.

"It is very much still, in terms of forward guidance, to say that it is in a relaxing mode, in a monetary policy stance which certainly would consider further relaxation of monetary policy if deemed appropriate at the next meeting," he said.

Fiscal Slippage

But there was possibility of fiscal slippage with weak imports reducing border taxes and slow growth also reducing domestic taxes, while expenditure was rising which argued against a rate cut.

The monetary board cut floor of its policy corridor 50 basis points in May, as liquidity built up from dollar purchases after private credit went negative triggering a collapse in imports and a balance of payments surplus.

Coomaraswamy said there was also a current account surplus in 2019.

Sri Lanka repaid debt on a net basis the first quarter, amid a credit collapse which tends push the financial account towards a deficit.

The ceiling 8.50 percent rate is not active when credit is weak and there is balance of payments surplus.

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Until May 31 the central bank was preventing rates from falling by withdrawing cash at around 8.50 percent.

Since the rate cut, the domestic operations department had allowed the overnight rate to fall to around 7.70 percent or about 80 basis points bigger than the rate 50 basis point rate cut, though the de facto target rate had moved up over the last two days.

The central bank had also slapped price controls on deposit rates, and has warned that it may impose controls on lending as well, unless lending are brought down further by banks.

Weak Credit

Private credit by banks fell by 2 billion rupees in May according to data released by the central bank.

Coomaraswamy said that the policy loosening in the recent months is yet to be seen translating into the economy.

Sri Lanka’s growth may remain weak in the near term due to the fallout from the Easter Sunday bombings and will recover in the fourth quarter of 2019 due to a lower growth base in 2018, he said.

Lending rates have been moving downwards slowly, but has to be expected as the deposit controls are only effective on new fixed deposits, Coomaraswamy said.

He said that how far banks will reduce lending rates would also be considered before moving for a rate cut.

"We will observe the reduction in lending rates going forward to see how that plays out before making another call on interest rates."

"So it’s a question of allowing some space to see some impact of recent monetary policy measures," he said.

Economic growth too was below a potential 5 percent denoted by econometrics at only 3.2 percent in the first quarter of 2019, while inflation was within the 4-6 percent target range.

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The central bank has also been mopping up inflows by selling down its Treasury bill stock, keeping policy tighter than a fixed exchange rate. Propping up rates via repo auctions also keep rates tighter than a currency board, analysts say.

The policy however is not contradictory. In 2018 the central bank was defending a peg and printing money to boost credit and generate balance of payments trouble, which was contradictory and the rupee collapsed from 153 to 182 to the US dollar.

It is now defending a peg and withdrawing cash, but there is enough liquidity left over. (Colombo/Jul11/2019)