ECONOMYNEXT – Sri Lanka’s would prefer not impose interest rates ceilings but would like to see rates falling naturally, Central Bank Governor Nandalal Weerasinghe said, after the agency warned it would use administrative measures to bring rates down.
“We will allow markets to respond first,” Governor Weerasinghe told reporters.
“If its not responding then obviously as you remember there are lending rate caps and deposit rate caps, there are other administrative measures that I think we can use.
“But I would basically prefer not to come up with administrative measures and let the market itself adjust and respond to the situation.”
Governor Weerasinghe said in the central bank’s view the market was “not perfectively competitive” and fully “liquid.”
Sri Lanka’s interest rates generally spike after the central bank inject money to mis-target rates triggering forex shortages and full-blown foreign currency crises.
Rates usually start to come down after a successful float restores confidence in the currency and excess liquidity starts to build up from central bank purchases of dollars.
Under an International Monetary Fund program the currency is briefly floated to end conflicts between money and exchange rate policies, and then re-pegged to collect dollars to meet a Net International Reserve target.
This time, though external stability has broadly been restored there has not been a explicit float to convince market players although external stability has been largely restored after the central bank ran out of foreign reserves and market rates were allowed to go up to curb credit.
The currency crisis has been extended into a sovereign default, requiring debt re-structuring which is delaying a deal with IMF.
The currency generally faces upward pressure for a year or more amid weak private credit under an IMF program.
The short-term yield curve then starts to slope upwards. Then entire yield curve then comes down as corrections are made to budget.
Analysts had warned that high interest rates are prevailing far longer than previous crises in 2022 due to failure to establish full credibility of the exchange rate with a surrender requirement in place as well as fears of domestic debt re-structuring.
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The longer the high rates prevail, the slower the eventual credit and economic recovery.
There are also private ouflows from the banking system as well as bilateral loan repayments. Other loans are in default, but inflows are also weak.
In an IMF supported debt re-structuring framework, domestic currency securities investors could suffer a default and a second nominal re-structuring despite being prepared to roll-over debt.
Sri Lanka
(Colombo/Nov22/2022)