• Monetary Board concerned over anomalous rise in market lending and deposit interest rates
• Governor says CB will intervene only if markets fail to respond
• Warns failure by markets to respond will result in reintroducing deposit and lending caps
• Reiterates hope of interest rates stabilising
• Private sector credit contracts for fifth consecutive month

By Charumini de Silva

The banking regulator yesterday said it will only intervene if markets fail to respond, expressing that the liquidity position is also recuperating.

“We expect liquidity position will also move in the same direction of inflation deceleration path,” Central Bank Governor Dr. Nandalal Weerasinghe said at the post-Monetary Policy Review Meeting yesterday.

However, he said that in the event market will not react, the Central Bank will opt for other administrative measures.

“I prefer not to come up with administrative measures but to let the market itself adjust and respond to the situation. We will first monitor how the markets will respond. If markets are not responding, we will then intervene if necessary,” he added.

Dr. Weerasinghe said failure by the markets to respond accordingly would result in reintroducing mechanisms such as deposit and lending caps. 

When asked if long-term rates falling faster than short terms were positive or negative on the market, the Governor explained it as a good sign. 

“Inflation is falling, liquidity in the dollar market is improving, and the inter-bank liquidity shortage has also reduced,” he said.

He asserted that to ensure liquidity and an effective market, it is essential for the market to adjust and not allow the Central Bank to intervene. 

“I can see market sentiments are improving and hopefully the interest rates will stabilise too,” Dr. Weerasinghe added.

In its post-Monetary Policy Review meeting statement, CBSL said Monetary Board had noted with concern the anomalous rise in market interest rates, particularly deposit interest rates and short-term lending interest rates. This was despite the recent improvements in overall money market conditions and the adverse implications on business and economic activity.

It said that market deposit interest rates have risen notably disproportionate to the adjustment in the policy interest rates. The continued excessive upward adjustment in market interest rates, despite the improvements in domestic money market liquidity and the deceleration of inflation, has resulted in persistent anomalies in the interest rate structure.

The Central Bank said it would expect a moderation of excessive market interest rates, in line with the prevailing policy interest rates.

“If an appropriate downward adjustment in the market interest rates would not take place in line with the envisaged disinflation path, the Central Bank will be compelled to impose administrative measures to prevent any undue movements in market interest rates,” it warned.

CBSL also announced that outstanding credit extended to the private sector by commercial banks is expected to have contracted for the fifth consecutive month in October 2022, reflecting the impact of increased market lending interest rates and the moderation in economic activity.

Separately, yields on Government securities are showing some signs of easing recently and are expected to moderate further.

“Going forward, the anomaly in market interest rates is expected to be rectified, benefiting mainly from the notable reduction in the overall money market liquidity deficit and the anchoring of inflation expectations in line with the envisaged disinflation path,” CBSL said.

Further, the high risk premia attached to the yields on Government securities are expected to shrink in the period ahead as the debt restructuring process progresses and fiscal sector performance improves with the consolidation measures in place.

The Board was of the view that the prevailing tight monetary policy stance is necessary to rein in any underlying demand pressures in the economy.

The Monetary Board also reiterated its continued commitment to restoring price stability and ensuring financial system stability and remains confident that inflation would follow the projected disinflation path underpinned by the prevailing monetary policy stance, while supporting the economy to reach its potential over the medium-term. “The Board remains ready to react appropriately to any materialisation of risks to the forecast,” CBSL added.

Monetary Board keeps policy rates unchanged