By CentralBankNews.info
Sri Lanka’s central bank left its key interest rates unchanged but lowered its Statutory Reserve Ratio (SRR) on all commercial banks’ rupee deposits by another 100 basis points to 5.0 percent to tackle a large and persistent deficit of liquidity in domestic money markets.
In November last year the Central Bank of Sri Lanka (CBS) cut SRR by 150 basis points to 6.0 percent to free up around 90 billion rupees in liquidity but also raised its two policy rates to maintain a neutral policy stance.
Despite this injection of liquidity, CBS said the domestic money market continues to be tight, partly because the government is relying more on domestic sources of financing while credit to both public and private sectors expanded more than expected last year amid borrowers’ response to policies aimed at limiting imports of motor vehicles and other non-essential goods to narrow the trade deficit.
Short-term money market rates have therefore remained in the upper bound of the policy rate corridor despite what CBS described as “appropriate” open market operations and other market interest rates have also remained at elevated levels.
The new reserve ratio will take effect on March 1 and the decision to retain the central bank’s Standing Deposit Facility Rate (SDFR) at 8.0 percent and the Standing Lending Facility Rate (SLFR) at 9.0 percent was taken to stabilize inflation at mid-single digit levels and enable the economy to reach its potential.
Sri Lanka’s inflation rate rose to 3.7 percent in January from 2.8 percent in December but CBS expects inflation to remain in its desired range of 4.0-6.0 percent in 2019 and beyond.
Sri Lanka’s economy has slowed in recent quarters and growth is projected to remain subdued in the fourth quarter of 2018 and this year before slowly reaching its potential in the medium term amid a low inflation environment, a competitive exchange rate and policies that support investment.
In the third quarter gross domestic product grew 2.9 percent, down from 3.6 percent in the second quarter.
Hit by a political crises, delayed discussions with the International Monetary Fund (IMF) on a 6th loan tranche and ratings downgrades by all three main ratings agencies, Sri Lanka’s rupee fell sharply in the second half of last year before recovering in January, supported by net inflows to the government securities market and a slowdown in imports.
Today the rupee was trading at 179.5 to the U.S. dollar, up 1.9 percent this year but down 14.5 percent since the start of 2018.
By end-January, gross official reserves had fallen to US$6.2 billion, enough for 3.4 months of imports, from $7.9 billion at the end of October 2018 and $7.0 billion end-November.
The Central Bank of Sri Lanka issued its first monetary policy review of 2019:
Economic growth remains below potential
Available leading indicators and current projections suggest that Sri Lanka’s real economic growth will continue to remain subdued during the fourth quarter of 2018 as well, and economic growth in 2019 is also expected to be modest. The economy is expected to gradually reach its potential in the medium term benefitting from the low inflation environment, competitive exchange rate and appropriate policies to support investment.
Headline inflation and core inflation as measured by the year-on-year change in both Colombo Consumer Price Index (CCPI, 2013=100) and National Consumer Price Index (NCPI, 2013=100) increased in January 2019 mainly due to the increase in non-food inflation driven by higher expenditure on certain items such as house rentals and education. Recent upward adjustments to fuel prices as well as possible increases in administratively determined prices of certain commodities could exert some transitory price pressures in the coming months. However, domestic supply side developments are expected to be favourable in the period ahead. Projections indicate that inflation is likely to remain in the desired 4-6 per cent range in 2019 and beyond.
External sector has witnessed some improvements so far in 2019 amidst challenging global economic conditions
Amidst a modest growth in exports, a slowdown in import expenditure was observed, particularly during the latter part of 2018, resulting from policy measures adopted by the government and the Central Bank to curtail motor vehicle and non-essential goods imports. These developments contained the trade deficit significantly in November and December 2018. The noticeable growth of earnings from tourism continued to support the current account of the balance of payments (BOP),although workers’ remittances recorded a marginal decline in 2018. In the financial account, foreign investments to the government securities market recorded a net inflow thus far during 2019. The Sri Lankan rupee strengthened somewhat underpinned by net inflows to the government securities market and the slowdown in imports along with changing global financial conditions. Meanwhile, Sri Lanka met the scheduled repayment of the maturing International Sovereign Bond of US dollars 1 billion in January 2019. By end January 2019, gross official reserves stood at US dollars 6.2 billion, which was sufficient to finance 3.4 months of imports.
Persistently tight liquidity conditions in the domestic money market
Deficit liquidity conditions in the domestic money market continued to persist at high levels, despite the liquidity injection through the reduction in SRR by 1.50 percentage points to 6.00 per cent in mid-November 2018. In the tight liquidity environment, the Central Bank continued to conduct open market operations appropriately, while allowing the short-term money market rates to remain around the upper bound of the policy rate corridor. Other market interest rates also remained at elevated levels both in nominal and real terms.
The monetary policy decision is expected to reduce the liquidity deficit in the domestic money market
Given the current and expected conditions in the domestic economy and financial market, the Monetary Board observed that the continuation of the current neutral monetary policy stance is appropriate. However, the Board was of the view that some policy intervention by the Central Bank to address the large and persistent liquidity deficit in the domestic money market is warranted. Accordingly, the Monetary Board decided to reduce the Statutory Reserve Ratio (SRR) applicable on all rupee deposit liabilities of commercial banks by 1.00 percentage point to 5.00 per cent from the current level of 6.00 per cent with effect from the next reserve maintenance period commencing 01 March 2019. The Standing Deposit Facility Rate (SDFR) and the Standing Lending Facility Rate (SLFR) of the Central Bank will remain unchanged at their current levels.”
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