Market Rates Inch Upwards amidst Liquidity Tightening to Control Higher Credit Growth

11th January 2012, www.island.lk

The Monetary Board of the Central Bank has decided to hold key interest rates unchanged because it feels rising market interest rates would dampen demand and keep a check on growing credit, the bank announced. However, the sale of dollars to keep the exchange rate stable is drying up rupee liquidity in the system as well, and the Central Bank has made no mention of this aspect in its Monetary Policy Review for January which was released yesterday (Jan. 11).

The repurchase rate will remain unchanged at 7 percent and the reverse repurchase rate will stay steady at 8.50 percent. These rates apply to commercial bank overnight deposits of excess rupees with the Central Bank and for borrowings from the Monetary Authority as a last resort to maintain liquid positions.

Interest rates have come under pressure in recent months as liquidity tightened in the market due to high credit growth and dollar sales by the Central Bank to keep the rupee stable against the dollar despite severe import demand.

"Credit obtained by the private sector remained robust through 2011, and by November, recorded a year-on-year growth of 33.5 percent. Largely reflecting the robust expansion of credit, broad money growth also remained at a level higher than that projected for 2011. Year-on-year growth of broad money (M2b) was 20.6 percent by November. However, market interest rates moved upwards in recent months, in line with changing liquidity conditions in the domestic money market," the Central Bank said.

"As a result, the benchmark yield on one year Treasury bills recorded an increase of around 175 basis points in 2011, while the average weighted deposit rate (AWDR) recorded an increase of about 100 basis points. Meanwhile, the average weighted prime lending rate (AWPR) increased by around 120 basis points in 2011, although at the last auction, the weighted average yields on Treasury bills in the primary market remained unchanged, indicating some stabilisation in market conditions. These moderate upward movements in interest rates are likely to exert a restraining effect on monetary aggregates, which would, in turn, help to curb the build up of demand pressures," it said.

Dealers said pressure on yields was evident at this week’s auction of Treasury bills, but with state-names participating, the Central Bank could control rates to a certain degree. Interbank interest rates increased further yesterday.

The Sri Lanka Inter Bank Offered Rate increased to 9.12 percent yesterday from 8.84 percent the previous day.

Call money market rates for interbank borrowings without security edged up to 9.12 percent from 8.92 percent and market repo rates for borrowings backed by Treasury bills inched up to 8.30 percent from 8.11 percent.

The movement in these rates were kept in check by the Central Bank infusing Rs. 20 billion into the market through a cash auction, buying up Treasury bills at 8.17 percent.

Treasury bills stayed flat at yesterday’s auction.

The rupee closed at Rs. 113.89/90 against the dollar yesterday as the Central Bank continues to sell dollars to stabilise the rate at this level.

The bank has spent more than US$ 850 million on keeping the exchange rate steady since the rupee was devalued last November, Reuters reported yesterday. It spent a net US$ 1.79 billion in the first 10 months of last year to keep depreciation pressure at bay.

"Taking into consideration the above developments, the Monetary Board is of the view that the present policy framework does not require any adjustment and accordingly, at its meeting held on January 10, 2012, decided to maintain the Bank’s policy interest rates unchanged at their current levels, i.e., the Repurchase rate at 7.00 percent and the Reverse Repurchase rate at 8.50 percent, the Central Bank said.

With the country’s balance of payments under siege, as some dealers say, the Central Bank continued to be optimistic about the near term scenario on the external front. Notwithstanding the impact higher interest rates would have on finance costs, the Central Bank says inflation would remain at mid single digit levels throughout this year.

"In the third quarter of 2011, GDP grew by 8.4 per cent, with all three sectors, Agriculture, Industry and Services, contributing towards that growth performance. GDP growth in 2011 is estimated to be around 8.3 per cent. In the meantime, the significant structural changes that have taken place in the Sri Lankan economy over the last several years are expected to provide the momentum for the economy to grow by about 8 per cent in 2012, even in the midst of the slowdown in global economic activity," the Central Bank said.

"Continued development efforts aimed at improving economic and social infrastructure are expected to augment the productive capacity of the country and thereby enable the realisation of the country’s growth potential. Improvements in infrastructure would also help eliminate supply bottlenecks, thus helping to reduce price pressures. As inflation is expected to remain around mid-single digit levels in 2012, broad money (M2b) is expected to grow by around 15 per cent in 2012, as announced in the ‘Road Map for Monetary and Financial Sector Policies for 2012 and beyond’.

"The ongoing structural changes in the economy are also likely to be reflected in the external sector, with earnings from tourism projected to increase to US dollars 1.2 billion, migrant worker remittances expected to increase to US dollars 6.5 billion, foreign direct investment (FDI) projected to record US dollars 2.0 billion, and inflows of debt capital to the private sector also expected to increase significantly in 2012.

"On the fiscal front, preliminary estimates indicate that the government has contained the fiscal deficit to a level within the revised target of 7 per cent of the GDP in 2011. It is expected that the government would bring down the fiscal deficit to 6.2 per cent of the GDP in 2012, thereby augmenting the resource availability to the private sector further," the Central Bank said.

Dealers point out that increasing interest rates would make consolidation of the fiscal balance challenging.

Treasury Secretary Dr. P. B. Jayasundera recently called for a tightening of monetary policy (increasing rates) coupled with another devaluation of the rupee.

The release of the next regular statement on monetary policy will be on 9th February 2012.

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