Sri Lanka’s call money rates have been around floor 4.50 percent and the central bank has been a net buyer in forex markets showing that liquidity is generated from dollar purchases amid negative private credit, and money need not be printed to bring rates down and trigger further monetary instability.
However last month money was printed to target Treasuries yields further down the yield curve, which Sri Lanka’s central bank is also controlling.
The agency said its rate setting monetary board decided to hold the policy corridor at 4.50 percent (at which excess money is withdrawn in times of weak credit) and 5.5 percent (at money is printed when credit picks up).
But it will shortly issue price controls on lending rates.
The central bank also resorted to price controls in the wake of the 2018 currency crisis, triggered by liquidity injections below the ceiling rate as credit picked up.
“The Board decided to adopt targeted measures to reduce specific interest rates that it considered to be excessive, which would help marginal borrowers,” the agency said.
“Considering bank lending rates of certain financial products which continue to remain high, the Board decided to revise downward the caps on interest rates on credit cards to 18 per cent per annum, on pre-arranged temporary overdrafts to 16 per cent per annum and on pawning facilities to 10 per cent per annum.
“Moreover, the Board was of the view that penal interest rates need to be capped at 2 percentage points over the regular interest rates charged on the relevant credit facility.”
In April Sri Lanka imposed the worst import controls seen since the collapse of the Bretton-Woods system of soft-pegs in 1971 as the rupee was allowed to fall from money printed in March and private credit surged.
The extent to which the import controls contribute to the contraction in private credit as activities in domestic companies with global supply chains gradually grinds to a halt is not clear.
Several large firms have said they are putting off capital expenditure.
The full statement is reproduced below:
The Central Bank of Sri Lanka continues its accommodative monetary policy stance
The Monetary Board of the Central Bank of Sri Lanka, at its meeting held on 19 August 2020, decided to maintain the Standing Deposit Facility Rate (SDFR) and the Standing Lending Facility Rate (SLFR) of the Central Bank at their current levels of 4.50 per cent and 5.50 per cent, respectively. The Board recognised the necessity to continue the accommodative monetary policy stance, particularly as market lending rates are yet to reflect the full passthrough of policy easing measures implemented thus far. The Board decided to adopt targeted measures to reduce specific interest rates that it considered to be excessive, which would help marginal borrowers.
The Board anticipates a further reduction in overall market lending rates, thereby encouraging borrowing for productive economic activity and reinforcing support for COVID-19 hit businesses as well as the broader economy, given the conditions of subdued inflation.
Global monetary easing continued amidst the rapid spread of the COVID-19 pandemic The rapid spread of the COVID-19 pandemic and related containment measures have resulted in a significant downturn in the global economy in the first half of the year. In response, almost all central banks of advanced economies as well as emerging market and developing economies continued to implement monetary easing measures, alongside fiscal stimulus by respective governments, in support of the recovery of economic activity.
Domestic economic activities, which were adversely affected by the COVID-19 pandemic, are expected to recover in the second half of 2020.
As per the provisional estimates released by the Department of Census and Statistics (DCS), the Sri Lankan economy contracted by 1.6 per cent in the first quarter of 2020, contrary to the expectations of the Central Bank. As per the available indicators, the adverse impact of COVID-19 on economic activity during the second quarter of 2020 is likely to be substantial. However, a faster rebound of economic activity is expected, especially in the fourth quarter of 2020, supported by improved political stability, the resultant improvement in business confidence, and the lagged impact of monetary and fiscal stimulus. This expected rebound in the fourth quarter is essential for the country to record a positive growth rate during this year.
The enhanced focus on domestic production for import substitution as well as to export is expected to drive near term growth, with potentially significant implications on the longer horizon. Sustaining the growth momentum beyond the near term would require reforms to address structural issues in the economy.
External sector has improved with the support of proactive policy measures
The external sector continued to demonstrate resilience, reflecting the impact of prudent measures implemented amidst the COVID-19 outbreak. The trade deficit has narrowed during the first half of 2020, as the contraction of imports outpaced the contraction of exports, supported by import restrictions and subdued global petroleum prices.
Some improvement in workers’ remittances was observed in June, in contrast to the declining trend observed since March 2020. However, the tourism sector, which has been forced to rely on domestic tourism for its survival in the face of the pandemic, is poised to witness a sizable decline in foreign exchange earnings in 2020.
Depreciation of the Sri Lankan rupee against the US dollar has been limited to 1.3 per cent thus far during the year, following a significant depreciation recorded during March-April 2020. With the Central Bank buttressing its reserves through foreign currency purchases from the market and foreign currency swaps with the Reserve Bank of India and licensed banks, gross official reserves were estimated at US dollars 7.1 billion by end July 2020, providing an import cover of 4.7 months.
No demand driven inflationary pressure is expected during the forecast horizon
Headline and core inflation, based on the Colombo Consumer Price Index (CCPI) accelerated marginally in July 2020, yet remaining at relatively low levels. The National Consumer Price Index (NCPI) based headline and core inflation also accelerated in June 2020, mainly reflecting the impact of food inflation.
In spite of such short term fluctuations, inflation is expected to remain broadly within the desired 4-6 per cent range in the near to medium term, with appropriate policy measures.
Slow growth of credit to the private sector is expected to recover gradually in the period ahead
Growth of credit extended to the private sector by commercial banks decelerated in June 2020, year-on-year, while the outstanding volume of credit contracted during June 2020 for the second consecutive month, in spite of the large surplus liquidity in the market. However, a gradual recovery in credit extended to the private sector is expected in the period ahead, driven by increased economic activity, improving business sentiment with enhanced political stability, declining market lending rates and rising credit disbursement on account of concessional credit schemes for businesses affected by the pandemic.
Credit to the public sector, in the meantime, soared in recent months reflecting the government’s heightened funding requirement, thereby causing a notable expansion of broad money thus far in 2020.
The impact of monetary easing measures is reflected in the recent notable decline in market interest rates
A noticeable decline in market lending rates was observed in July 2020 in response to the series of policy and regulatory measures adopted by the Central Bank thus far in 2020. With the gradual reduction in market lending rates, interest rates applicable on new lending by commercial banks, on average, have now reduced to single digit levels. The Average Weighted Prime Lending Rate (AWPR) has also declined significantly in recent weeks. While the recent decline in overall market interest rates is encouraging, some market lending rates still remain excessive, affecting marginal borrowers in particular. Overall market lending rates are expected to decline further, commensurate with monetary easing measures adopted in the recent past, enhancing the affordability of credit, which is imperative to support the recovery of economic activity in the period ahead.
Policy rates maintained at current levels, while further measures to promote lending introduced
In consideration of the current and expected macroeconomic developments as highlighted above, the Monetary Board, at its meeting held on 19 August 2020, was of the view that the current accommodative monetary policy stance is appropriate, and decided to maintain the Standing Deposit Facility Rate (SDFR) and the Standing Lending Facility Rate (SLFR) of the Central Bank at their current levels of 4.50 per cent and 5.50 per cent, respectively.
Considering bank lending rates of certain financial products which continue to remain high, the Board decided to revise downward the caps on interest rates on credit cards to 18 per cent per annum, on pre-arranged temporary overdrafts to 16 per cent per annum and on pawning facilities to 10 per cent per annum. Moreover, the Board was of the view that penal interest rates need to be capped at 2 percentage points over the regular interest rates charged on the relevant credit facility.
Directions to effect these regulated interest rates will be issued shortly. The Central Bank will continue to monitor domestic and global macroeconomic and financial market developments and take further measures to support the economy to return to a higher growth path without delay, given subdued levels of inflation.