Sri Lanka will hike rates if there is more global instability: CB Governor

ECONOMYNEXT – Sri Lanka may have raise interest rate if there is more global instability leading to foreign outflows, though a recent rate hike was ‘unfortunate’, Central Bank Governor Arjuna Mahendran said.

"We had to resort to the unfortunate interest rate hike last week on the basis that growth of bank lending is running at 25 percent," Central Bank Governor Arjuna Mahendran told reporters.

"It’s a good thing that banks are willing to lend. But if we end up with a massive credit bubble, it will create more problems than it solves."

He said under the central bank’s governing law, it was obliged to send a report to the finance minister if credit growth exceeds 15 percent.

But credit growth topped 26 percent in November and December.

Foreign bond holders were also selling out of the market creating pressure on the rupee.

If global instability continues, Sri Lanka may have to raise rates again, he said.

Bond holders were selling because they feared more losses with the rupee depreciating and the US dollar strengthening.

"We have to preserve our currency from going into a fee fall," Mahendran said.

"Raising interest rates will ensure that the currency stabilizes and settles down."

Sri Lanka has a de facto peg with the US dollar and runs into currency trouble every time the credit cycle turns, because the central bank delays rate hikes by printing money, either the finance deficits or because it is growth happy, critics have said.

Mahendran said policy rates were now back at levels seen in April when 50 basis point rate cut was made.

In April the central bank cut policy rates, despite rising domestic private and state credit and analysts were expecting balance of payments trouble.

However active defence of the peg, mops up liquidity that is generate and pushes interest rates upward, helping regain some economic stability.

Banks on their own raised deposit rates about 200 basis points since October 2015. Raising deposit rates allows banks to generate more deposits and extend more credit for investments by curbing consumption. (Colombo/Feb26/2016)