CB gives in, cuts policy rates

Says latest downward revision would signal to the market the need for further reductions in market interest rates and expansion in credit to the private sector

After facing some apparent criticism over its stand of not encouraging a more desired downward trend in interest rates, Central Bank last week reduced its policy rates
The Monetary Board, at its September 11 meeting decided to reduce its policy interest rates by 50 basis points each. Accordingly, the Repurchase rate and the Reverse Repurchase rate of the Central Bank would be 8.00 per cent and 10.50 per cent, respectively.
The Bottom Line in its August 19 issue highlighted that Interest rates, a major throttle to companies and key to spur a quicker recovery in the economy, weren’t declining but not fast enough.
In its August meeting the Monetary Board took a softer view and remained passive by not revising downwards its policy rates, a move which surprised financial and business circles.
For the second straight month, in August, the Central Bank unchanged its stance over Repo and Reverse Repo rates which remain at 8.50% and 11%. The last downward revision was in June by 50 basis points while early this year they amounted to 10.25% and 11.75% respectively.
“Market interest rates continue to decline in response to the monetary policy measures but they are yet to adjust fully to the policy rate reductions,” the Central Bank reasoned after its August monetary policy review this week.
Even in last week’s statement, the Bank said with the gradual relaxation of its monetary policy stance, though short term interest rates have declined in line with the policy rate reductions, there has not been an appreciable reduction in lending rates in general, and credit flows to the private sector have not picked up as desired.
In that context the Bank said the latest cut in policy rates “would signal to the market the need for further reductions in market interest rates and expansion in credit to the private sector.”
The Bank said Inflation, as measured by the year-on-year change in the Colombo Consumers’ Price Index (base=2002), has remained around 1 per cent during the last three months. While inflation is expected to gradually rise to moderate levels in the approaching months, it is projected to remain at single digit levels during the rest of 2009.
“Current projections indicate that inflation, on a year-on-year basis, would be at low single digit levels even by the end of 2010,” the Bank added.
It said economic prospects for Sri Lanka had improved considerably during the past few months. With the contraction in the world economy now widely believed to have bottomed out, the scope for domestic economic activity is now even wider.
The Bank also said during the first six months of this year, it eased its monetary policy stance in several steps to support domestic economic activity, in view of the sharp decrease in inflation, the improved outlook for inflation and the significant slowdown in domestic economic activity in the face of the global economic downturn.