Sri Lanka hikes policy rates

The Monetary Board of Sri Lanka has finally decided to increase the policy rates by 50 basis points amidst increased private sector credit growth that is widening the trade deficit and falling foreign reserves. Accordingly, the Central Bank of Sri Lanka (CBSL) in a statement said the new Repurchase rate and the Reverse Repurchase rate will be 7.50 and 9 percent respectively. The CBSL said credit granted by commercial banks to the private sector increased by 34.5 percent, year-on-year, in December 2011, substantially exceeding projections, driven by import related items such as motor vehicles.

Import related credit increased by over 34 per cent during 2011, while the increase in credit for export activity was only around 8 per cent during the year. Pawning also displayed a significant increase in 2011.

“In addition, credit granted to the Government and public corporations by commercial banks increased considerably, and in particular, a higher petroleum import bill and the inadequate adjustment to domestic petrole- um prices led to increased borrowings by the Ceylon Petroleum Cor poration (CPC)” the CBSL said. At the same time, excess liquidity in the domestic money market declined from Rs.124 billion as at end 2010 to the current level of around Rs 15 to 20 billion, and such decline in liquidity in the domestic money market resulted in market interest rates recording an upward movement in recent months.

“With excess liquidity declining, commercial banks also competitively raised interest rates paid on deposits, with rates on 3-month and 6-month term deposits showing a considerable increase during the past few months,” CBSL noted. The CBSL also said gross official reserves (excluding Asian Clearing Union balances) declined to US dollars 5.9 billion by end December 2011, representing the equivalent of 3.6 months of imports. Sri Lanka being an importoriented country, CBSL has been defending the LKR to keep inflation at single digit levels, while keeping the interest rates down to spur growth.

“Consequent to the increased domestic economic activity, low interest rates, as well as the high energy prices in the international market, the total expenditure on imports increased substantially to US dollars 18.4 billion during the first eleven month of 2011 widening the trade deficit. This was in spite of earnings from exports increasing by 22.2 per cent to US dollars 9.6 billion during the period,” the CBSL said.

Taking into consideration these macroeconomic developments, the Monetary Board of the Central Bank is of the view that the continuous increase in credit extended to the private sector by commercial banks needs to be addressed for two main reasons.

Here, the CBSL wants to curtail import-related credit and thereby reduce both the trade deficit and the current account deficit, and secondly to effectively ensure that inflation remains at the mid-single digit levels in the second half of 2012 as well, notwithstanding the sharp build up of credit in 2011.