Sri Lanka Keeps Policy Rates & Treasury Yields Stable, Inflation Subdued

21st May 2010, www.island.lk, By Devan Daniel

The Monetary Board of the Central Bank has decided to keep rates at which commercial banks lend or borrow from the Central Bank stable as inflation remains subdued while benchmark Treasury bill rates remained relatively stable this week with the bank financing the payment of maturing bills amounting to a little more than Rs. 1.5 billion.

The point-to-point change in inflation fell to 5.8 percent in April after reaching above 6 percent in March but the annual change in the rate of inflation moved up to 3.4 percent, raising since 3.1 percent last February.

"Price pressures in the economy have been dampened by improvements on the supply side, particularly the noteworthy performance in paddy production. Prices of key commodities in the international markets also remain subdued," the Central Bank said.

For these reasons, price pressures are expected to be subdued in the short term, the bank said in its monetary policy review for May.

Therefore, the Monetary Board of the Central Bank ahs decided to keep policy interest rates unchanged at 7.5 percent and 9.25. These rates apply to overnight placement of excess funds of commercial banks (repurchase rate) with the Central Bank and borrowings (reverse repurchase rate) form the Central Bank respectively.

The Central Bank said credit to the private sector had improved with positive growth for March 2010 after making negative gains since April last year, but no figures were given. The latest Weekly Economic Indicators published by the bank indicates a 2.8 percent drop in private sector credit last February from the previous year.

However, the Central Bank said credit to the private sector is picking up.

"The gradual expansion in credit obtained by the private sector indicates the solidifying recovery in the economy," it said.

However, the Central Bank earlier this month said that it was constantly asking commercial banks to revise their lending rates to more reasonable levels and that credit to the private sector was too slow to recover despite loosening monetary policy throughout the latter part of 2009.

Dealers said excess liquidity in the rupee market continued to be high. Dealers said the surplus reached Rs. 33 billion as at Wednesday. With commercial banks still cautious in their lending to the private sector, government securities were the preferred option.

Meanwhile, broad money growth fell to 17.1 percent year-on-year this March from 18.6 percent as at end 2009. "Broad money growth remains compatible with the levels targeted in the monetary programme at the beginning of the year," the Central Bank said.

Broad money is defined as the sum of currency held by the public and all deposits held by the public with commercial banks. This is a popular variable that is used to analyse the relationship between the money supply and the general price level, or inflation.
Treasury yields stable
Treasury bill rates remained relatively stable at this week’s primary market auction of maturing bills amounting to Rs. 13 billion. The Central Bank accepted re-issued Rs. 11,443 million of these financing the settlement of the balance Rs. 1,557 million with access funds held in its position.

The six-month and 12-month Treasury bill rates remained unchanged at 8.88 percent and 9.23 percent respectively from a week ago but the yield on the three-month bill increased marginally to 8.13 percent from 8.18 percent a week ago.

The Rs. 13 billion maturing bills attracted bids amounting to Rs. 24.62 billion from primary dealers but only Rs. 11.4 billion was accepted with the balance bought by the Central Bank. Analysts said this was done by printing new money but a top Central Banker said the bank has a stock of excess funds for this purpose.

IMF and budget deficits
The biggest risk to maintaining low inflation and low interest rates is from the budget deficit and Central Bank warned that the government would have to contain high deficits.

The IMF is expected to announce the fate of the US$ 2.6 billion standby facility programme today after it deferred the payment of the third US$ 326 million tranche earlier this year when the government overshot the 7 percent of GDP deficit target for 2009, reaching 9.8 percent.

The government announced that it would target a deficit of 7.5 percent this year which would be brought down to 5 percent by 2012, but the IMF said it would want to see the proof when the next budget is announced.

The next budget is to be announced in November for the 2011 fiscal year. An interim budget for this year is to be announced by the end of June.

Although Sri Lanka has built comfortable levels of foreign exchange reserves, more than US$ 5 billion, economists point out that the continuance of the IMF programme would give long term investors confidence in Sri Lanka’s macroeconomic prospects.

An IMF mission is in the island and is expected to complete its review of the standby facility programme today.