Apr 22, 2014 (LBO) - Sri Lanka's central bank held policy rates unchanged in April saying reduced central government and state enterprise borrowings has created conditions for private credit to pick up.
The central bank held the rate at which money is drained from banks at 6.5 percent and the rate at which cash is injected at 8.0 percent.
With excess liquidity in markets and money being drained daily amid weaker credit, the 6.5 percent standing repo rate is now active and overnight risk free bank rates is 6.50 percent and the un-backed rate at 6.90 percent.
Inflation
The Central Bank said the rates were appropriate with inflation at 4.2 percent in March, up slightly from 3.1 percent in February,
"Looking ahead, although some price pressures may be felt due to supply disruptions brought by drought conditions, inflation is expected to remain at mid single digits throughout the year supported by favourable inflation expectations, and subdued demand conditions," the April monetary policy statement said.
In a country with free trade, a drought may temporarily push up a price index but does not cause inflation unless it is accommodated in some way with looser monetary policy.
Higher prices in some sectors may squeeze the prices in others when the so-called 'supply shock' is not is not accommodated.
In Sri Lanka rice is hit by import taxes and kept at rates higher than the rest of the world and potatoes are also taxed to give rents to landowners and a farming lobby backed by economic nationalism.
Rice taxes have been relaxed ahead of the drought though prices are now up. Meanwhile traders have been slapped with price controls.
Sri Lanka's inflation has been low with credit weak and excess liquidity being drained by the Central Bank, with some analysts saying inflation would be lower if the exchange rate was allowed to appreciate.
Credit
The government had borrowed 43.3 billion rupees from the banking system in the first two months of the year but overdrafts at state banks had been repaid with proceeds of a billion US dollar bond.
State energy enterprises had also repaid loans from state banks.
"Continued fiscal consolidation, together with the sovereign bond issuance that took place in April 2014, is expected to ease public sector’s reliance on bank financing in the coming months," the Central Bank said.
"The resulting release of funds for private investments bolstered by sufficient market liquidity levels would provide the necessary stimulus to strengthen private sector activity and in turn, as expected, expand credit growth from the second quarter onwards."
Sri Lanka raised interests sharply in 2012 to ward of a balance of payments crisis triggered by heavy borrowings by state enterprises from state banks amid a general credit bubble.
In February private sector credit growth had slowed to 4.4 percent from 5.2 percent in January.
Many over-leveraged private firms had reduced leverage following the end of a credit bubble and slowing economic activity.
The Central Bank said a part of the reduction in credit came from reduced gold-backed loans which had also risen sharply during a worldwide gold price bubble. But gold prices fell during 2013, leaving banks exposed and taking steps to provide for losses.
Some banks were also exposed to margin loans given during a stock market bubble.
Analysts a period of consolidation where bad debts acquired during the bubble are purged would leave banks in a stronger footing to fund a recovery and is part of a business or credit cycle.
The central bank held the rate at which money is drained from banks at 6.5 percent and the rate at which cash is injected at 8.0 percent.
With excess liquidity in markets and money being drained daily amid weaker credit, the 6.5 percent standing repo rate is now active and overnight risk free bank rates is 6.50 percent and the un-backed rate at 6.90 percent.
Inflation
The Central Bank said the rates were appropriate with inflation at 4.2 percent in March, up slightly from 3.1 percent in February,
"Looking ahead, although some price pressures may be felt due to supply disruptions brought by drought conditions, inflation is expected to remain at mid single digits throughout the year supported by favourable inflation expectations, and subdued demand conditions," the April monetary policy statement said.
In a country with free trade, a drought may temporarily push up a price index but does not cause inflation unless it is accommodated in some way with looser monetary policy.
Higher prices in some sectors may squeeze the prices in others when the so-called 'supply shock' is not is not accommodated.
In Sri Lanka rice is hit by import taxes and kept at rates higher than the rest of the world and potatoes are also taxed to give rents to landowners and a farming lobby backed by economic nationalism.
Rice taxes have been relaxed ahead of the drought though prices are now up. Meanwhile traders have been slapped with price controls.
Sri Lanka's inflation has been low with credit weak and excess liquidity being drained by the Central Bank, with some analysts saying inflation would be lower if the exchange rate was allowed to appreciate.
Credit
The government had borrowed 43.3 billion rupees from the banking system in the first two months of the year but overdrafts at state banks had been repaid with proceeds of a billion US dollar bond.
State energy enterprises had also repaid loans from state banks.
"Continued fiscal consolidation, together with the sovereign bond issuance that took place in April 2014, is expected to ease public sector’s reliance on bank financing in the coming months," the Central Bank said.
"The resulting release of funds for private investments bolstered by sufficient market liquidity levels would provide the necessary stimulus to strengthen private sector activity and in turn, as expected, expand credit growth from the second quarter onwards."
Sri Lanka raised interests sharply in 2012 to ward of a balance of payments crisis triggered by heavy borrowings by state enterprises from state banks amid a general credit bubble.
In February private sector credit growth had slowed to 4.4 percent from 5.2 percent in January.
Many over-leveraged private firms had reduced leverage following the end of a credit bubble and slowing economic activity.
The Central Bank said a part of the reduction in credit came from reduced gold-backed loans which had also risen sharply during a worldwide gold price bubble. But gold prices fell during 2013, leaving banks exposed and taking steps to provide for losses.
Some banks were also exposed to margin loans given during a stock market bubble.
Analysts a period of consolidation where bad debts acquired during the bubble are purged would leave banks in a stronger footing to fund a recovery and is part of a business or credit cycle.
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