Central Bank of Sri Lanka Raises Reserve Ratio to 8pct to Control Inflation

12th April 2011, www.lankabusinessonline.com

Sri Lanka's central bank raised its reserve ratio, the amount of deposits that banks must hold at the monetary bank by 100 basis points to 8.0 percent to draw in excess liquidity and contain inflation.

Sri Lanka's inflation accelerated to 8.6 percent in March, the highest in two years amid excess liquidity and also transient supply tightness.

Excess liquidity which was hovering around 80 to 90 billion rupees in February and March 2010 fell to 68 billion on April 12 due to the cash draw downs from banks for the traditional New Year that falls this week.

The Central Bank said broad money grew 17.7 percent in February, with private sector credit growing 29.7 percent.

"While the excess liquidity in the domestic money market remains a concern, left unchecked, it could further expand monetary aggregates, leading to higher inflation than originally envisaged," the Central Bank said in its monetary policy statement.

"Thus, the Monetary Board considers it prudent to pull back any buildup of demand-side pressure on inflation and ensure continued monetary stability."

The reserve ratio increases costs of banks and decreases their ability to lend, as they now have to keep the equivalent of 8 percent of their deposits with the Central Bank without earning interest.

Excess liquidity is rupee reserves in commercial banks, which are over and above the defined reserve money.

Reserve money or the monetary base is the the narrowest form of money supply through which all final transactions in the economy are cleared. It is made up of notes in circulation plus the statutory deposits at the Central Bank, which has now been increased.

But during Christmas and the traditional New Year holiday, notes in circulation expands, increasing the monetary base.

The festival draw down had reduced excess liquidity.

The banking system's excess liquidity came from foreign inflows as well as about 14 billion rupees printed to finance the budget deficit in January under Sri Lanka's flawed monetary law.

Central Bank Governor Nivard Cabraal said the reserve ratio increase will draw out about 15 billion rupees from the economy.

Related Info :

• Sri Lanka’s Inflation Rises. Central Bank Keeps Rates Steady in the Face of less Price Pressure despite Floods

• Sri Lanka Budget Deficit Falls to 7.9pct of GDP in 2010 - Annual Report of the Central Bank of Sri Lanka