Sri Lanka cuts policy rates 50bp to boost credit

ECONOMYNEXT – Sri Lanka’s central bank has cut policy rate 50 basis points, to lower market interest rates and boost credit amid an uptick in deposit rates after price controls were lifted and Treasuries yields gained after taxes were slashed.

“This decision supports a continued reduction in market lending rates, thereby facilitating the envisaged recovery in economic activity given the favourable medium term outlook for inflation, which is well anchored within the 4-6 per cent range,” the central bank said in its January monetary policy statement.

The central bank cut the ceiling of its policy corridor at which money is injected from 8.0 percent to 7.50 percent and the floor rate at which money is taken out from 7.00 percent to 6.50 percent.

Overnight money has ranged around 7.50 percent.

Sri Lanka’s deposit rates have picked up after price controls were lifted and Treasury bill yields have also picked up after the government cut value added tax, raising prospects of higher domestic borrowings.

“In response to monetary and regulatory measures taken by the Central Bank, market lending rates adjusted downwards, but the pace of reduction has decelerated,” the central bank said.

“The reduction in lending rates thus far, except for the Average Weighted Prime Lending Rate (AWPR), has been less than envisaged.”

Banks have loaned 58 billion rupees in new credit to private borrowers in December up from 47 billion rupees in November.

Sri Lanka’s private credit fell after a collapse of the rupee in 2018 from 152 to 182 to the US dollar in the wake of corrective policies needed to stop further falls and loss of reserves.

Sri Lanka’s soft-peg with the US dollar generally runs into currency troubles as rates are cut and liquidity injections are made to enforce them, as either private credit, government borrowing or both pick up.





Amid weak credit the rupee has been stable, though there were liquidity disruptions after July. There has been inflows to bond markets in January.

Analysts have pointed that credit tends to contract after the central bank prints money triggers a collapse in the soft-dollar peg but the economy recovers after about 18 months.

In the previous eight months, banks only loaned a net 42 billion rupees in credit following a collapse of the rupee and corrective policies required to halt a further falls.

Private credit volumes have been positive since August and banks have loaned a total of 149 billion rupees in of new credit in the past four months requiring more deposits to be raised.

The central bank also lifted price controls in deposit rates slapped earlier in the year.

“With the removal of caps on deposit interest rates offered by banks, new deposits rates have increased since September 2019,” the central bank said.

” Yields on Treasury bills have trended upwards at recent auctions. If not addressed, these trends could result in an undesirable turnaround in market lending rates.”

Sri Lanka has slashed value added taxes, raising fears over domestic borrowings in 2020, while private credit also picks up.

In December credit to government surged to 64.9 billion rupees, from a negative 26 billion rupees in November.

State enterprises had also borrowed another18 billion rupees in December central bank data shows, adding further pressure to the credit system.

Sri Lanka’s CEB has been operating thermal generators and selling power at a loss, driving up losses.

Up the end of December however the rupee has been stable, and there had also been inflows in bond markets in January.

The central bank expects inflation to be below 5 percent in 2020.

“In spite of such short term fluctuations, the near term forecast suggests that inflation will hover below 5 per cent in 2020, and stabilise between 4-6 per cent thereafter, assisted by appropriate policy measures and underpinned by well anchored inflation expectations.”

The central bank said economic growth will pick up in 2020, with tax cuts, improved business confidence and ‘monetary measures’.

“The economy is expected to reach its full capacity over the medium term, benefitting from the low and stable inflation environment, a competitive exchange rate, low lending rates as well as improved consumer and investor sentiment,” the statement said.

“The growth momentum of the economy is expected to be sustained through the implementation of appropriate structural reforms designed in line with the policy priorities of the government.” (Colombo/Jan30/2020)

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