Central Bank seen holding rates, SRR steady

Reuters: Sri Lanka’s Central Bank will announce its January monetary policy rate decision today.

The Central Bank is expected to keep its repurchase and reverse repurchase rates steady at 7 per cent and 8.50 per cent respectively, their lowest levels in more than seven years, for a 12th straight month, according to 12 out of 14 analysts polled by Reuters.

One analyst expects a 50 basis points (bps) hike in the both repurchase and reverse repurchase rates, while another predicts a 25 bps increase in the both.

On reserve ratios, one analyst expects the central bank to cut the Statutory Reserve Ratio (SRR) for commercial banks by 100 bps, while one expects a 50 bps cut. All others expect it to be unchanged at 8 per cent.

Factors to watch

International Monetary Fund officials are expected to visit the country on 25 January to discuss the possibility of disbursing the eighth trance of a $2.6 billion loan.

The tranche has been on hold since September due to the Central Bank’s failure to implement a flexible exchange rate regime. The funds, if disbursed, will help the Central Bank maintain a low interest rate regime and support the economy.

Treasury bill yields have jumped between 117-172 bps after the three percent currency devaluation on 21 November, pushing markets interest rates higher. Tight liquidity, as a result of the central bank’s dollar sales to defend the rupee, is pushing market rates higher, analysts say.

The Central Bank has spent more than $ 820 million on keeping the rupee steady since it was devalued on 21 November. It also spent a net $ 1.79 billion in the first 10 months of 2011 to keep depreciation pressures at bay.

Economists and analysts say the central bank has been over optimistic in targeting $ 25 billion foreign inflow, 8 per cent economic growth along with record exports earning and remittances in 2012 as the country’s main export markets Europe and Middle East are in turmoil.

Private sector credit growth eased to 33.4 per cent year-on-year in October, hovering near a 16-year high of 34.4 per cent recorded in September. The Central Bank wants to slow it to 27 per cent by end 2011 and further to 16 per cent by end 2012.

Foreign inflows into Government securities after the Central Bank increased the foreign holding limit to 12.5 per cent from 10 per cent.

Low inflation has created ample room for the Central Bank to relax policy rates further. Annual inflation was 4.9 per cent in December, a 16-month low due to a better local food supply and lower global commodity prices. But economists expect the trend to reverse after the devaluation.

Market impact

The stock market, which is on a sliding trend due to credit concerns, may be unaffected if the central bank holds rates, while money market rates may rise as liquidity is expected to remain tight.

The rupee may weaken if rates are kept on hold as the continuation of an easy rate regime may encourage importers to step up their overseas purchases and boost dollar demand. However, dealers say declining reserves are beginning to test the bank’s ability to defend the rupee.