Sri Lanka cuts SRR 150 bps but raises depo rate 75 bps15th November 2018
Sri Lanka’s central bank lowered its reserve requirement on banks’ deposits to boost liquidity in the domestic money market and reduce the cost of funds but also raised its two key policy rates to neutralize the impact of this injection of money to maintain a neutral monetary policy stance.
The Central Bank of Sri Lanka (CBS) cut the Statutory Reserve Ratio (SRR) by 150 basis points to 6.0 percent as of Nov. 16, saying this should release “a substantial” amount of liquidity to counter a “large and persistent liquidity deficit” in the domestic money market that has driven up the cost of funds for banks.
This lack of liquidity has required the central bank carry out to open market operations on a short- and long-term basis, in addition to overnight operations.
But given the current and expected trends in inflation and economic growth, CBS said it wanted to maintain an overall neutral policy stance so it raised the Standing Deposit Facility Rate (SDFR) by 75 basis points to 8.0 percent and the Standing Lending Facility Rate (SLFR) by 50 basis points to 9.0 percent, narrowing the rate corridor to 100 points.
This narrowing is also expected to narrow the spread between market deposit and lending rates.
Today’s rate hike is CBS’ first rate change since April this year when the lending rate was lowered by 25 basis points to 8.50 percent while the deposit rate was maintained at 7.25 percent to narrow the policy rate corridor to help control short-term interest rates and reduce their volatility.
Sri Lanka’s headline inflation rate dipped to a 2018-low of 3.1 percent in October but is expected to rise and remain within the central bank’s target range of 4.0 to 6.0 percent during 2019 and “thereafter with appropriate policy adjustments,” CBS said.
Sri Lanka’s rupee has dropped sharply this year, especially in September, due to a general rise in the U.S. dollar, with the rupee’s decline boosted by capital outflows and a surge in imports.
“Although the pace of deprecation has moderated recently, the Sri Lankan rupee has depreciated by 12.9 percent against the U.S. dollar during 2018 up to 13 November,” CBS said, adding gross official reserves at the end of October amounted to US$7.9 billion, enough for 4.2 months of imports.
Sri Lanka’s trade deficit has widened this year as import earnings have outpaced the growth in exports but CBS expects imports to slow in the period ahead due to recent import controls and the depreciation of the rupee.
Sri Lanka’s economy is expected to remain subdued this year and below expected levels, CBS said.
Last month CBS expected growth in the second half of this year to pick up speed from the first half. In the second quarter Sri Lanka’s economy grew by 3.7 percent year-on-year, up from 3.5 percent in the first quarter.
The Central Bank of Sri Lanka issued the following statement:
In order to neutralise the impact of this reduction and maintain its neutral monetary policy stance, the Monetary Board decided to increase the Standing Deposit Facility Rate (SDFR) of the Central Bank by 75 basis points to 8.00 per cent and the Standing Lending Facility Rate (SLFR) of the Central Bank by 50 basis points to 9.00 per cent.
The Board arrived at this decision following a careful analysis of current and expected developments in the domestic and global economy and the domestic financial market, with the broad aim of stabilising inflation at mid single digit levels in the medium term to enable the economy to reach its potential.
Tight monetary conditions persisted in the domestic market
The large and persistent shortage in rupee liquidity required the Central Bank to conduct open market operations (OMOs) on a short- and long-term basis in addition to overnight operations. Overnight interest rates were allowed to remain around the upper bound of the policy interest rate corridor reflecting the prevailing liquidity conditions. The yields on government securities experienced a notable increase in recent weeks while most other market interest rates remained high both in nominal and real terms.
Year-on-year growth of broad money (M2b) continued its deceleration in September 2018. Nevertheless, there was a possibly short-lived acceleration in credit obtained by the private sector from commercial banks as the businesses advanced their borrowing in anticipation of measures to curb excessive spending on imports. Based on the data up to the third quarter of 2018, credit to all major sectors of the economy recorded an expansion with personal loans and advances showing a notable acceleration. It is expected that the growth of credit to the private sector would return to the expected path as measures taken by the government and the Central Bank gain traction.
Headline inflation, based on both the Colombo Consumer Price Index (CCPI) and the National Consumer Price Index (NCPI), decelerated below the desired mid single digit levels, largely driven by the decline in volatile food prices. Core inflation has also remained subdued reflecting well anchored inflation expectations due to the tight monetary policy stance maintained in the past. With these developments, headline inflation is projected to remain in low single digit levels during the remainder of the year and is expected to be maintained in the targeted range of 4 – 6 per cent during 2019 and thereafter with appropriate policy adjustments.
Both international and domestic developments affected the external sector performance
The expansion in import expenditure continued to outpace the growth in export earnings during the first nine months of 2018 leading to a wider trade deficit than in the corresponding period in the previous year. However, a slowdown in import expenditure is expected in the period ahead in response to the recent measures adopted as well as the depreciation of the rupee against major currencies. The moderation in tourism related inflows and workers’ remittances remained a concern in terms of theperformance of the external current account. In the financial account, both the government securities market and the Colombo Stock Exchange experienced net outflows of foreign investment, particularly in the context of rising global interest rates and elevated political uncertainty.
The significant growth in imports as well as recent capital outflows amidst the broad based strengthening of the US dollar exerted pressure on the exchange rate. Although the pace of depreciation has moderated recently, the Sri Lankan rupee has depreciated by 12.9 per cent against the US dollar during 2018 up to 13 November. Meanwhile, supported by the receipt of the foreign currency term financing facility of US dollars 1 billion by the government, gross official reserves amounted to US dollars 7.9 billion as at end October 2018, providing an import cover of 4.2 months.
As per the available economic indicators, real GDP growth is likely to remain subdued and below the envisaged levels in 2018. In order to accelerate growth on a sustainable basis, it is essential that growth enhancing structural reforms are carried out within a coherent and transparent framework, rather than relying on unsustainable short term monetary and fiscal stimulus, which leads to overheating of the economy.
The monetary policy decision is expected to have a neutral effect on the market
Considering the current and expected developments in relation to inflation and economic growth, as well as the current conditions in the domestic money market and the foreign exchange market, the Monetary Board of the Central Bank, at its meeting held on 13 November 2018, was of the view that the continuation of the current neutral monetary policy stance is appropriate.
However, the Monetary Board observed that large and persistent liquidity deficit in the domestic money market requires policy intervention, and decided to reduce the Statutory Reserve Ratio (SRR) applicable on all rupee deposit liabilities of commercial banks by 1.50 percentage points to 6.00 per cent from the current level of 7.50 per cent with effect from the next reserve maintenance period commencing 16 November 2018.
The reduction in SRR is expected to release a substantial amount of rupee liquidity to the banking system, thus reducing the cost of funds of banks. At the same time, in order to neutralise the impact of the SRR reduction and maintain its neutral monetary policy stance, the Monetary Board decided to raise policy interest rates of the Central Bank with immediate effect.
Accordingly, the Monetary Board raised the Standing Deposit Facility Rate (SDFR) by 75 basis points to 8.00 per cent and the Standing Lending Facility Rate (SLFR) of the Central Bank by 50 basis points to 9.00 per cent, thereby narrowing the policy rate corridor to 100 basis points. These adjustments are also expected to narrow the spread between deposit and lending rates in the market.”
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