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Sri Lanka slashes policy rates 100bp amid Coronavirus slowdown

ECONOMYNEXT – Sri Lanka has slashed policy rate 100 basis points bringing the rate at which money is injected to the banking system at 5.50 percent and the rate at which excess money is withdrawn to 4.50 percent.

“The spread of the COVID-19 pandemic has significantly impacted near term growth prospects globally, while available indicators for Sri Lanka also suggest that economic growth is likely to have been severely affected during the second quarter of 2020,” the rate setting Monetary Board of the central bank said.

“The Board arrived at this decision with a view to inducing a further reduction in market lending rates, thereby encouraging the financial system to aggressively enhance lending to productive sectors of the economy, which would reinforce support to COVID-19 hit businesses as well as to the broader economy, given conditions of subdued inflation.”

“Although a rebound is expected during the second half of the year with the support of monetary and fiscal stimulus measures, the introduction of growth promoting and confidence enhancing structural reforms is imperative to foster high and sustainable economic growth over the medium term.”

Money market rates have been hovering around the earlier floor policy rate of 5.50 percent amid excess liquidity injected through domestic asset purchases in March and April which triggered pressure on the currency and led to import control hitting businesses and the economy in general.

However private credit has also been weak, which tends to keep rates near the floor rate.

Sri Lanka’s central bank generally triggers monetary instability by injecting large volumes of money to keep rate below the ceiling rate or in the middle of the corridor as the economy recovers from the last balance of payments crisis and credit picks up, analysts have showed.

Credit to private sector was about 30 billion rupees in May, data shows, though there is a pick up in credit to government as the deficit expands.

The central bank has also cut the statutory reserve ratio, one of the reasons Sri Lanka’s interest rates have been are higher than other countries with greater monetary stability.

Excess liquidity coming from domestic asset purchases eventually results in foreign exchange shortages (and reserve losses when the liquidity is mopped up through dollar sales) in a pegged exchange rate system when credit picks up.

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Over the last week the central bank withdrawn some excess liquidity from the system. More liquidity is also due to be injected through central bank ref-finance of bank credit and discounting of contractor bills.

The full statement is reproduced below:

The Monetary Board of the Central Bank of Sri Lanka, at its meeting held on 08 July
2020, decided to reduce the Standing Deposit Facility Rate (SDFR) and the Standing Lending
Facility Rate (SLFR) of the Central Bank by 100 basis points each, to 4.50 per cent and 5.50
per cent, respectively. The Board arrived at this decision with a view to inducing a further
reduction in market lending rates, thereby encouraging the financial system to aggressively
enhance lending to productive sectors of the economy, which would reinforce support to
COVID-19 hit businesses as well as to the broader economy, given conditions of subdued
inflation.

The spread of the COVID-19 pandemic has significantly impacted near term growth prospects
globally, while available indicators for Sri Lanka also suggest that economic growth is likely to have
been severely affected during the second quarter of 2020. Although a rebound is expected during the
second half of the year with the support of monetary and fiscal stimulus measures, the introduction of
growth promoting and confidence enhancing structural reforms is imperative to foster high and
sustainable economic growth over the medium term.

On the external front, the trade deficit is estimated to have narrowed during the first five
months of 2020, with the contraction in imports outweighing the contraction in exports. Reflecting
the impact of measures taken to stem foreign currency outflows, the Sri Lankan rupee, which remained
volatile briefly from mid-March to mid-April 2020, recorded a notable appreciation thereafter. Gross
official reserves stood at US dollars 6.7 billion by end June 2020, sufficient to cover 4.2 months of
imports.

Market interest rates continued to decline, reflecting the impact of policy rate reductions and the surplus liquidity in the domestic money market. However, further space remains for market lending rates to adjust downwards commensurate with the series of easing measures taken by the Central Bank thus far during the year. Despite high levels of surplus liquidity available to banks, credit extended to the private sector contracted significantly in May 2020.

However, credit extended to the private sector is likely to pick up in the period ahead, supported by the expected sharp reduction in lending rates and highly concessional credit schemes introduced to support COVID-19 hit businesses. Meanwhile, the notable increase in credit to the public sector drove the increase in domestic credit as well as the overall monetary expansion during the first five months of 2020.

In consideration of the need to support a rapid recovery of the economy, the Monetary Board, at its meeting held on 08 July 2020, decided to reduce the Standing Deposit Facility Rate (SDFR) and the Standing Lending Facility Rate (SLFR) of the Central Bank by 100 basis points each to 4.50 per cent and 5.50 per cent, respectively, with effect from 09 July 2020. The Monetary Board wishes to strongly reiterate that all financial institutions led by licensed commercial banks (LCBs) must pass on the full benefit of the cumulative reduction of 250 basis points in policy interest rates thus far during the year without delay.

LCBs are also expected to release to the private sector borrowers the enhanced levels of liquidity effected by the reduction of the Statutory Reserve Ratio (SRR) by 300 basis points thus far during the year, which has also reduced the cost of funds of banks. Such additional liquidity must be used to lend to productive sectors of the economy, along with concessionary credit schemes already announced by the Central Bank to help needy sectors of the economy. The Central Bank will continue to monitor domestic and global macroeconomic and financial market developments and take further measures to ensure that the intended outcomes of already implemented policies are realised.

The spread of the COVID-19 pandemic has significantly impacted near term growth prospects globally, while available indicators for Sri Lanka also suggest that economic growth is likely to have been severely affected during the second quarter of 2020.

Although a rebound is expected during the second half of the year with the support of monetary and fiscal stimulus measures, the introduction of growth promoting and confidence enhancing structural reforms is imperative to foster high and sustainable economic growth over the medium term.

The Monetary Board of the Central Bank of Sri Lanka, at its meeting held on 08 July 2020, decided to reduce the Standing Deposit Facility Rate (SDFR) and the Standing Lending Facility Rate (SLFR) of the Central Bank by 100 basis points each, to 4.50 per cent and 5.50 per cent, respectively. The Board arrived at this decision with a view to inducing a further reduction in market lending rates, thereby encouraging the financial system to aggressively enhance lending to productive sectors of the economy, which would reinforce support to COVID-19 hit businesses as well as to the broader economy, given conditions of subdued inflation.

The spread of the COVID-19 pandemic has significantly impacted near term growth prospects globally, while available indicators for Sri Lanka also suggest that economic growth is likely to have been severely affected during the second quarter of 2020. Although a rebound is expected during the second half of the year with the support of monetary and fiscal stimulus measures, the introduction of growth promoting and confidence enhancing structural reforms is imperative to foster high and sustainable economic growth over the medium term.

On the external front, the trade deficit is estimated to have narrowed during the first five months of 2020, with the contraction in imports outweighing the contraction in exports. Reflecting the impact of measures taken to stem foreign currency outflows, the Sri Lankan rupee, which remained volatile briefly from mid-March to mid-April 2020, recorded a notable appreciation thereafter. Gross official reserves stood at US dollars 6.7 billion by end June 2020, sufficient to cover 4.2 months of imports.