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By Uditha Jayasinghe
The Central Bank yesterday reduced the Statutory Reserve Ratio (SRR) by 1% to 5% with effect from 1 March with the aim of injecting Rs. 60 billion into the market to spur growth and reduce liquidity shortages, but kept policy rates unchanged to offset a spike in inflation and spillover into imports.
The Monetary Board kept the Standing Deposit Facility Rate (SDFR) and the Standing Lending Facility Rate (SLFR) of the Central Bank at 8% and 9%, respectively.
Central Bank Governor Dr. Indrajit Coomaraswamy explained that the move was to reduce liquidity shortages still observed in the market though the SRR was reduced in November to inject about Rs. 90 billion into the market.
“We estimate there is need for Rs. 100 billion in the market and this change will meet part of that demand. The remainder will be handled by market forces. In Sri Lanka, when there are large amounts of liquidity, it tends to spill over into more imports, which could affect our reserves. So we have decided to keep rates unchanged to counter any such problems,” he told reporters.
When rates are lower, consumption-related loans tend to increase with the public opting to import cars or move into sectors such as construction that have a significant import component. This in turn tends to place pressure on reserves and push Sri Lanka into a balance of payments crisis. The Governor insisted that the aim was to foster growth but not place any pressure on reserves, which are needed to repay debt.
The Board arrived at this decision following a careful analysis of current and expected developments in the domestic economy and the financial market as well as in the global economy with the broad aim of stabilising inflation at mid-single digit levels in the medium term to enable the economy to reach its potential, the Central Bank said.
“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 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,” the monetary policy statement said.
Despite an uptick in inflation in January, inflation outlook remains favourable in the medium term. Headline inflation and core inflation as measured by the year-on-year change in both Colombo Consumer Price Index and National Consumer Price Index increased in January 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% range in 2019 and beyond.
The 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 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 $ 1 billion in January. By end January, gross official reserves stood at $ 6.2 billion, which was sufficient to finance 3.4 months of imports.
Persistently tight 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% points to 6% 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.
Expansion in credit to both public and private sectors was more than expected in 2018 irrespective of tight market liquidity conditions and high interest rates. This was partly attributable to the private sector borrowers’ short-term responses to policies adopted to limit imports and related expectations. The Government also relied more on domestic sources of financing, while the weak financial performance of State-owned business enterprises also contributed to credit growth.
However, driven by the contraction in net foreign assets of the banking sector, the year-on-year growth of broad money (M2b) decelerated by end-2018 as envisaged. 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% to 5% from the current level of 6% with effect from the next reserve maintenance period commencing 1 March. The Standing Deposit Facility Rate (SDFR) and the Standing Lending Facility Rate (SLFR) of the Central Bank will remain unchanged at their current levels.
