ECONOMYNEXT – Sri Lanka’s central bank hiked bank reserve ratios 150 basis points to 7.50 percent regressing into an archaic policy tool and kept its low policy rate corridor unchanged as inflation picked up and the currency slid to new historic lows.
Banks will now have to keep 7.50 percent of their deposits with the central bank instead of 6.0 percent earlier, making the entire financial system more inefficient and raising intermediate costs.
Most modern central banks have abandoned the reserve ratio as a monetary policy tool.
The central bank’s policy corridor will be kept at 6.0 percent to withdraw liquidity and 7.50 percent to inject cash into the system.
However in practice it had been injecting tens of billions of rupees of cash into the system at the 3-month Treasury bill rate of around 6.0 percent and overnight rates have even fallen below the lower end of the policy corridor to around 5.5 percent due to operations flaws in the liquidity windows.
The central bank said credit to private sector grew 26.3 percent in the year to October and broad money grew 17 percent. In earlier reasons not to raise policy rates the Central Bank has said that low credit growth in previous years justified high credit growth this year.
"Meanwhile, excess liquidity in the domestic money market continues to remain high fuelling monetary expansion," the Central Bank said, not mentioning that the excess liquidity was its own creation by printing tens of billions of rupees to finance the budget deficit and keep rates artificially low.
Inflationary pressures was rising the Central Bank finally said, which other analysts and the International Monetary Fund have been warning for several months.
A newly created national consumer price index showed inflation climbing to 4.8 percent in November from 3.0 percent in October and a core inflation index covering the capital Colombo to 4.4 percent from 4.3 percent.
For most of 2015, the Central Bank had been giving various excuses for not raising policy rates and generated a balance of payments crisis, driving the country towards an International Monetary Fund bailout.
The hike in reserve ratios can curb the ability of banks to lend the deposits it raises, and push up lending rates, but it does not address the fundamental problem of liquidity creation by the central bank and repaying maturing Treasuries with printed money.
Unlike rate hikes, reserve ratio increases do not persuade people to save more and reduce consumption allowing loans financed by real deposits to grow without de-stabilizing the economy. (Colombo/December30/2015 – Update III)