Interest rates told to head south!

The Monetary Board yesterday reinforced its stand to the banking sector that interest rates must decline further, though the financial services industry appears to be having some reservations and other regional central banks have been hiking rates.

The emphatic message from the Monetary Board came despite or amidst a high 23% year-on-year growth in credit to private sector on top of an 18% improvement in October.

The Daily FT on Monday reported that end October data revealed credit to private sector had increased by Rs. 218.6 billion to Rs. 1.41 trillion.

However, the high percentage growth is from a lower or negative base of 2009. For example, in November 2009, credit growth to private sector was down by 6%.

To cement the road for downward revision in interest rates, the Central Bank said yesterday that the Monetary Board at its meeting on Monday had decided to reduce the Repurchase rate by 25 basis points and the Reverse Repurchase rate by 50 basis points to 7% and 8.5%, respectively, with effect from 11 January 2011.

In support of the move the Central Bank said, “The encouragement of substantial and sustained private sector participation in economic activity in the years ahead would be vital.”



“Towards that end, a reasonable relaxation of the Central Bank’s monetary policy stance would be appropriate and timely. Such a policy stance would result in a further reduction in market interest rates, which would reflect the lower risk premia that is expected to prevail in the period ahead, without increasing the inflationary pressures in the economy,” the Central Bank said in its statement post the November Monetary Policy Review meeting.

Interestingly, the policy rate cut by the Monetary Board was contrary to the forecast by analysts in most banks as per a Reuters poll on Tuesday.

Basing it on the poll, Reuters said the Central Bank was expected keep both its Repurchase rate and Reverse Repurchase rate steady at multi-year lows of 7.25 per cent and 9 per cent respectively. Fourteen out of 15 analysts polled by Reuters gave that forecast. Only one analyst has predicted the Central Bank will raise both rates by 25 basis points.

The Reuters poll also said 10 analysts expect the Central Bank to raise both rates by at least 25 basis points in the second half of the year while four analysts expect that to happen in the second quarter.

Analysts from HSBC, Citibank, National Development Bank, Asia Capital, Commercial Bank of Ceylon, Hatton National Bank, People’s Bank, CT Smith Research, Frontier Research, Standard Chartered Bank, Bank of Ceylon, SC Securities, TKS Securities, Barclays Capital and Nations Trust Bank participated in the poll, which Reuters does regularly ahead of the monthly Monetary Policy Review.

In his speech at the ‘Roadmap for 2011 and Beyond’ recently, Central Bank Governor Nivard Cabraal said that interest rates in 2010 average reduction in lending rates was around 2%.  This was after it reduced policy interest rates in 2010 on the basis of the Repo rate by 25 basis points and Reverse Repo rate by 75 bps.

In October, the Central Bank requested all banks to reduce interest rates, subject to the following maximum rates: 14% p.a. on Housing loans and 24% p.a. On Credit card advances.

In its statement yesterday, the Central Bank said that the macroeconomic environment remains favourable.

It said that growth in broad money supply in 2010 recorded an average value of around 15%, thus remaining consistent with the target stipulated in the monetary programme for 2010.

Furthermore, data relating to developments on the fiscal front indicate that the deficit in the national budget would be well within the targeted 8% of GDP in 2010.  Meanwhile, the Government remains committed to securing a budget deficit of 6.8% of GDP in 2011 with current indications showing that such a deficit target is very likely to be achieved.

The Central Bank said the “favourable macroeconomic environment therefore provides the required space and comfort for new and wider investments to be made in all sectors of the economy, including new growth areas, without fuelling undue inflationary pressures in the period ahead, thereby firmly supporting the country’s  growth potential.”

It was in this scenario that the Monetary Board had effected the cut in policy rates on Tuesday.

The release of the next regular statement on monetary policy will be on 8 February 2011.

More cuts possible – CB Chief

Central Bank Governor Nivard Cabraal has said more cuts in interest rates are likely in the medium term.

“We are giving a clear indication that we are confident of the growth plus the low inflation trajectory we are moving towards,” Cabraal told Reuters after the release of the January monetary policy review.

The island-nation’s economy was estimated to have expanded by 8 percent last year, a 32-year-high, from an eight-year low of 3.5 percent in 2009. The central bank forecast record 8.5 percent growth in 2011, with inflation between 4 percent and 6 percent.

“I was very surprised by it,” Frontier Research economist Amal Sandaratne said. “We, of course, believe inflationary pressures are much higher than what the central bank sees.”

However, the central bank has said the rise in annual inflation, which hit a 21-month high in November, was mainly due to high food and commodity prices amid steady core inflation.

Cabraal expects transportation improvements and the greater area available for production since the end of a 25-year separatist war in May 2009 will help reduce supply-side price pressures.

“Overall, we are seeing the right engagements in the economy, and if we continue to see them, we can look at a more relaxed approach. We would be looking at the quality of credit growth ... a favourable response from the supply side,” he said.

Currency dealers said the market has been seeing around a 130 billion rupee surplus ($1.17 billion) since November, a sign that large companies had been holding out for further rate cuts before taking loans.

A Reuters poll had forecast rates would be held steady but the central bank cut the repurchase rate by 25 basis points to 7.00 percent and the reverse repurchase rate by 50 basis points to 8.50 percent, the lowest levels since November 2004.

The central bank has cut both rates by 350 basis points since February 2009, when it reversed a tight monetary policy stance it put in place to rein in double-digit inflation that peaked at 28.2 percent in July 2008.

By contrast, central banks in much of the rest of Asia have been steadily raising rates to keep mounting inflationary pressures in check, with further tightening expected this year.