ECONOMYNEXT – Sri Lanka’s central bank raised policy rates by 50 basis points taking the rate corridor to 6.50 percent and 8.0 percent, barely keeping pace with banks which had already raised deposit rates by higher amounts.
"…[I]nspite of the recent policy measures taken by the Central Bank and some upward adjustments observed in market interest rates, certain risks to macroeconomic stability continue," the monetary authority said in a February policy statement.
"In particular, the Monetary Board was of the view that the excessive growth of broad money fuelled by domestic credit expansion in the midst of continued upward trend in underlying inflation requires pre-emptive policy measures in order to contain further build- up of demand driven inflationary pressures."
The policy rate hike came after the banks on their own raised deposit rate by around 200 basis points over the past six months, bringing a much needed correction to the credit system.
The central bank said broad money (defined as M2b) grew 17.8 percent in the year to December 2015 compared to 13.4 percent in 2014.
In 2015 commercial banks had given 691.4 billion rupees in credit (up 25.1 percent), up from 223.9 billion rupees in (up 8.8 percent) in 2014.
Total loans given in December may have been around 43.6 billion rupees, much lower than in earlier months and in line with deposits raised by banks.
The Central Bank said inflation was only 0.9 percent in January 2015, measured by the Colombo Consumer Price Index, but it was 4.2 percent in January by a new National Consumer Price Index.
In December the central bank raised the reserve ratio by 150 basis points effective January, which economists said would make the banking sector more inefficient and will not solve the problem of low interest rates and money printing.
The Central Bank claimed that the SRR had "permanently absorbed a part of excess rupee liquidity from the domestic money market."
But analysts had pointed out the central bank itself had injected large volumes of money into the money market ahead of the SRR hike and continue to inject more money after the reserve ratio hike generating pressure on the currency.
A part of the recent injections however were to offset foreign investor bond sales, which were not directly related to rising domestic credit but domestic policy errors may have hurt confidence.
Already market rates have gone up "towards the levels observed prior to the reduction in policy interest rates in April 2015," the Central Bank said.
If the Central Bank did not inject money, continuously and used moral suasion on overnight money markets, policy rates would have been closer to the upper 7.5 percent bank by the middle of 2015, analysts say.
EN’s economic columnist says the central bank could still de-stabilize the credit system by injecting large volumes of cash permanently in to the credit markets by purchasing Treasury bills.
Even on Friday domestic assets of the Central Bank went up by over 20 billion rupees, indicating more permanent printing of money, though some of which had already moved out.
Foreign investors data showed had sold about 10 billion rupees of bonds.
Sri Lanka’s central bank has a history of printing money, delaying rate hikes and generating economic instability.
Critics have said that it either prints money and depreciates the currency steadily generating high inflation (in the 1980s and early 1990) or prints money and defends the currency generating balance of payments trouble or both and then runs to the International Monetary Fund.
The reverse repo rate at which money is injected to the banking system is now at 8.0 percent, the same level it was in April 2015, when rates were cut despite and expanding budget deficit and private credit that was turning sharply positive. (Colombo/Feb19/2016)