Central Bank raises key rates by 50 basis points

„Rising inflation and private credit triggers action „May private credit grows 28% or Rs.62 bn „Over Rs.273 bn credit extended to private sector during first 5 months „Hawkish Monetary Board says not hesitant to act if situation warrants

The Central Bank yesterday raised its key policy rates by 50 basis points after keeping the rates steady for five months as both the headline and core inflation point to an increasing trend and the demand for private credit continued to rise faster than required.

As a result the Monetary Board raised its Standing Deposit Facility Rate – the rate at which the Central Bank absorbed excess liquidity from the market to 7.00 percent from 6.50 percent while the Standing Lending Facility Rate – the rate at which the liquidity is injected – was raised to 8.50 percent from 8.00 percent.

“…further tightening of the monetary policy is required to curb excessive demand in order to pre-empt the escalation of inflationary pressures and to support the balance of payments,” a statement issued by the Central Bank said.

The market by and large expected a 50 basis points hike in key rates during the third quarter, and many factored this in their decisions, but not many thought the hike would strike this sooner.

“The Board is of the view that tightening of monetary policy in a forward looking manner will ensure the maintenance of inflation at mid-single digits in the medium term, which is supportive of the growth momentum in the economy.

As such, the current policy adjustment is not expected to have a significant impact on the long end of the yield curve,” the policy statement further added.

However yesterday’s decision is quite contrary to what the new Central Bank Governor said at the beginning of the month when he said he wanted to wait till the economy adjusted from the earlier monetary policy actions.

Generally monetary policy actions take 12 to 18 months to bring full effects to the economy, Dr. Indrajith Coomaraswamy said earlier this month.

HOWEVER ECONOMISTS HAILED THE ACTION BY THE MONETARY BOARD YESTERDAY AS THIS WILL PROVIDE MUCH RESPITE TO AN OTHERWISE OVERHEATING ECONOMY

The Central Bank in January 2016 raised the bank’s statutory reserve ratio by 150 basis points to 7.50 percent and subsequently in February raised the key policy rates by 50 basis points to curb an overheating economy, but these actions proved less effective.

However economists hailed the action by the Monetary Board yesterday as this will provide much respite to an otherwise overheating economy.

They believe it is sensible to tighten now and feel the tough times till the economy cools down, after which the Central Bank could ease slowly after assessing the macro-economic conditions.

Meanwhile private credit has grown by 28 percent year-on-year in May, translating into a massive Rs. 62 billion credit during the month alone.

This is far in excess of the 15 percent private credit growth targeted by the Central Bank for 2016.

During the first 5 months, the banking system has extended as much as Rs.273.2 billion to the private sector, which is considered high.

“Although some deceleration in the growth of broad money (M2b) supply was observed in the month of May 2016, monetary expansion remained above the desired levels,” the Monetary Board said. Sounding hawkish, the Monetary Board further said they would continue to monitor macroeconomic developments closely and make appropriate adjustments to the monetary policy stance, as and when necessary.