CB cuts lending rates to spur domestic growth

Staying true to promises, the Central Bank cut policy interest rates by 50 basis points yesterday, placing the Repurchase Rate at 7% and the Reverse Repurchase Rate at 9% in an effort to boost domestic growth while disregarding an International Monetary Fund (IMF) warning that the move could boost inflation.

The Central Bank in a media release remarked that subdued factory industry output and lower external trade were the key areas affected by the slow global economic recovery, and hence, there was now a growing need to enhance domestic demand and thereby provide greater stimulus to the domestic economy.

“In addition, the reserve maintenance period of commercial banks will also be increased to two weeks from one week with effect from 1 June 2013 in order to offer greater flexibility to commercial banks in managing their liquidity, while maintaining the Statutory Reserve Ratio at the current level of 8%.”

Sri Lanka’s exports for the first quarter dropped by 8.1% said data released by the Central Bank earlier this week.

Moreover, the IMF warned against easing rates last week pointing out that Sri Lanka has a history of high inflation due to loser monetary policy.

Undeterred the Central Bank defended the move pointing out that inflation rates have remained at single digit levels for over four years and do not pose an “immediate risk”.

“Inflation has remained within single digit levels over the past 51 months, declining to 6.4%, on a year-on-year basis, in April 2013. While the proposed electricity tariff adjustment will result in a modest increase in the Colombo Consumers’ Price Index (CCPI), it is anticipated that such increase will not lead to inflation rising above the single digit level,” it added.

Supported by the improvement in the current account, the balance of payments recorded a surplus of US$ 153.6 million by end March due to inflows into Government securities, net cumulative inflows into portfolio investments, and long term inflows to the Government, the statement noted.

Reflecting these developments, the Central Bank has purchased around US$ 547 million, on a net basis, during the first four months of the year, which has helped to raise gross official reserves of the country to US$ 6.9 billion, equivalent to 4.5 months of imports, as at end April.

The monetary authority also insisted that losses in State-owned enterprises, the exchange rate and trade deficit have been kept under control to justify the adjustment.

“The key indicators of the banking sector such as capital adequacy and return on assets have remained at favourable levels indicating the soundness of the financial sector. The gross non-performing loan ratio, however, increased marginally by March 2013, although still remaining at comfortable levels. In this regard, an easing of monetary policy is expected to improve the repayment capacity of borrowers.”

The Central Bank acknowledged that Government borrowing was high in the first quarter of 2013 in the face of lower revenue collection with net credit to the Government from the banking sector during this period amounting to Rs. 135 billion and the Central Bank’s Treasury bill holdings recording over Rs. 200 billion in early April.

Nevertheless, it insisted that the situation has improved during the past few weeks with the Government being able to settle a part of its dues through the retirement of Treasury bills held by the Central Bank, with the outstanding Treasury bill stock declining to Rs. 119 billion by end April.

“In this regard, a pick-up in domestic economic activity in the balance part of the year is expected to generate higher tax revenues, thereby helping achieve the fiscal targets set out for the year. Moreover, the expected moderation in market interest rates would also ease the financing cost of the Government debt, thus leaving greater resources to finance the public investment program of the Government.”

Continued decline in monetary aggregates were also predicted with little gains on the average growth of broad money in 2013.