Sri Lanka SRR hike will not have ripple effect on economy: CB Governor
ECONOMYNEXT – A hike in the statutory reserve ratio to 7.5 percent from 6.0 percent requiring lenders to keep a larger share of their deposits in the central bank will not have an effect on interest rates or the broader economy, Central Bank Governor Arjuna Mahendran said.
"I don’t think there will be much of a change," he told reporters responding to a question of how interest rates will change after the reserve ratio hike.
"There should not be any ripple effect on the broader economy."
A reserve ratio hike will limit the ability of banks to lend their deposits to 92.50 cents per rupee from the previous 94 cents.
This pushes up the cost of lending rates as banks now have to service the deposits from a lower volume of credit forcing them to charger higher lending rates. The total intermediation costs go up.
Unlike a policy rate hike, an SRR hike does not necessarily push up deposit rates, which is required to curb consumption, generate more resources for credit and investment.
Reserve ratios are an archaic tool that is not used by modern central banks that generate low levels of inflation.
Inflation targeting countries such as the New Zealand, Australia, UK and Sweden have completely abandoned reserve ratios, after realizing the futility of such tools.
The Euro zone has a nominal SRR of one percent. Some Eastern European countries, India, China, and African nations still use them.
Modern central banks do not use SRR hikes, not only because they are ineffective but also because there can be liquidity shocks to banks that do not have excess reserves.
The higher SRR will apply to commercial banks from January 16 and could withdraw an estimated 40 billion rupees from the banking system, allowing the Central Bank to print money for the government and minimise the negative effect on the economy and the currency, analysts say.
In January a so-called ‘provisional advance’ of interest free printed money will be given to the government expanding reserve money, credit and the hurting the currency and also reserves if the currency is defended to mop up the new money.
The new money usually go to state banks. The provisional advance does not give profits (seigniorage) to the central bank but generates reserve losses if the currency is defended and interest losses if the cash is sterilized.
Central Bank profit transfers have a similar effect.
By raising the SRR the central bank will be able to withdraw the new money at no cost to itself, but at the expense of long term efficiency and higher intermediation costs of the commercial banking system.
Sri Lanka’s central bank has been printing a large volume of money, generating currency pressure, inflation and forex reserve losses.
The Central Bank is obliged to give up to 10 percent of estimated revenues of the government as a provisional advance.
This year revenues have been widely over-estimated and a large volume of money will have to be printed in January, giving a larger than usual shock to the currency, and foreign reserves, with the SRR hike will ‘sterilize’ or withdraw from the banking system.
Since no interest is paid on the deposits, the Central Bank will also save money, but at the cost of greater inefficiency of the banking sytem.
Restraining the ability of the Central Bank to give ‘provisional advances’ should be a key part of a future reform of the monetary authority analysts have said. There have also been calls for the central bank to be abolished and a currency board re-established.
Top international economist Razeen Sally said it was a mistake to have abolished Sri Lanka’s currency board in 1951. Hong Kong which has a currency board, also has no reserve ratio. (Colombo/January01/2016)