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Saturday, 4 February 2012 00:00 - - {{hitsCtrl.values.hits}}
The Central Bank yesterday opted to its ways to fix the country’s reserves problems, effecting a policy rate hike for the first time since 2007 and directing banks to cut lending apart from a 20 cent devaluation of the rupee.
Though analyst polled by Reuters didn’t expect a rate hike, the overall market had anticipated it along with a sharper devaluation. It appears that the Central Bank relied more on the policy rate route and going bit soft with the exchange rate, outcomes of both would be seen only in the coming weeks and months.
Following the February monetary policy review, the Monetary Board of the Central Bank decided to increase both the Repurchase rate and the Reverse Repurchase rate by 50 basis points each. Hence, the Repurchase rate and the Reverse Repurchase rate will be 7.50 per cent and 9.00 per cent, respectively.
The Monetary Board also decided to direct commercial banks to moderate their credit disbursements so that the overall credit growth in 2012 will not exceed 18% of their respective loan book outstanding at the end of 2011, while credit growth of up to 23% will be allowed for those banks, which finance the excess up to 5% of the credit growth, from funds mobilised from overseas.
Following the rate hike, CB also increased the dollar buying rate by 20 cents to 114.10, dealers said. In addition, the Central Bank will also monitor on a regular basis, the targets for inflows as set out in the ‘Road Map: Monetary and Financial Sector Policies for 2012 and Beyond,’ with regard to Foreign Direct Investments (FDI), earnings from tourism, workers’ remittances, Tier 2 capital of banks, inflows to the stock market, inflows to the government securities market, and a credit line for petroleum imports, which would help increase net foreign exchange inflows to the country, thereby enabling the balance of payments to record a healthy surplus in 2012.
“The Monetary Board is of the view that these adjustments to the monetary policy stance of the Central Bank, as well as other measures that may be adopted by relevant Government authorities would materially reduce the need for the Central Bank to supply foreign exchange to the market, on a net basis, during 2012,” the statement following the meeting stated.
In justifying its decisions, the Central Bank said consequent to the increased domestic economic activity, low interest rates, as well as the unexpectedly high energy prices in the international market, the total expenditure on imports increased substantially to $ 18.4 billion during the first eleven month of 2011 widening the trade deficit. This was in spite of earnings from exports increasing by 22.2% to $ 9.6 billion during the period.
Increased earnings from tourism, increased workers’ remittances, and other inflows to the services account helped cushion the impact on the current account deficit, while the Central Bank had to intervene by supplying foreign exchange, on a net basis, to mitigate the undue pressure on the domestic foreign exchange market.
As a result, despite higher inflows of foreign direct investments and inflows to the Government, gross official reserves (excluding Asian Clearing Union balances) declined to $ 5.9 billion by end December 2011, representing the equivalent of 3.6 months of imports.
Meanwhile, credit granted by banks to the private sector increased by 34.5%, year-on-year, in December 2011, substantially exceeding projections, the Central Bank said. Provisional estimates indicate that within the credit extended to the private sector by commercial banks, trade related credit and credit driven by import-related items such as motor vehicles and consumer durables increased significantly.
Import-related credit increased by over 34% in 2011, while the increase in credit for export activity was only around 8% during the year. Pawning also displayed a significant increase in 2011. In addition, credit granted to the Government and public corporations by commercial banks increased considerably, and in particular, a higher petroleum import bill and the inadequate adjustment to domestic petroleum prices led to increased borrowings by the Ceylon Petroleum Corporation (CPC).
At the same time, excess liquidity in the domestic money market declined from Rs.124 billion at end 2010 to the current level of around Rs. 15 to 20 billion and such decline in liquidity in the domestic money market led to market interest rates recording an upward movement in recent months. With excess liquidity declining, commercial banks also competitively raised interest rates paid on deposits, with rates on 3-month and 6-month term deposits showing a considerable increase during the past few months.
Taking into consideration these macroeconomic developments, the Monetary Board said the continuous increase in credit extended to the private sector by commercial banks needs to be addressed for two main reasons; to curtail import related credit, thereby reducing the trade deficit and the current account deficit, and to effectively ensure that inflation remains at the mid-single digit levels in the second half of 2012 as well, notwithstanding the sharp build up of credit in 2011.
Inflation, as measured by the change in the Colombo Consumers’ Price Index (CCPI, base 2006/07), continued to moderate, with year-on-year inflation declining to 3.8% in January 2012 from 4.9% in December 2011.
While this is the 36th consecutive month with single digit inflation, improvements in domestic food supplies such as most varieties of vegetables, potatoes and big onions mainly contributed to the continuation of low inflation, whereas non-food inflation showed an increase during the month.
Meanwhile, year-on-year core inflation in January 2012 remained unchanged from the previous month at 4.7%, while Inflation measured by the Colombo Consumers’ Price Index continued to moderate, with year-on-year inflation declining to 3.8% in January from 4.9% in December 2011.
Bourse negative
As the Central Bank increased policy rates by 50 basis points and the exchange rate moved up, the share market fell in anticipation of a fallout on a shortened trading day before the Independence Day holidays.
Analysts said rising rates could lure investment away from the stock market to banks, apart from reducing demand and cut spending as borrowing becomes more expensive and loan repayments spiral.
“The regulators most recent decision to lift the policy rates by 50 basis points was for the first time since 2007. This could hold the potential of diverting funds from the stock market to Government securities that would now provide a higher return at a zero risk,” Arrenga Capital said.
The All Share Price Index dipped .34% to close at 5,586.4, increasing the year to date dip to over 8% and the Milanka Price Index fell .58% to 4,813.1 on a shortened trading day whilst turnover was Rs. 420 million.
