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Sri Lanka cuts interest rates to boost credit
12 Dec, 2012 08:52:13
Dec 12, 2012 (LBO) - Sri Lanka has cut its main policy rate at which money injected to banks by 25 basis points to 9.50 percent to boost loans and the Central Bank said a credit ceiling would expire by the end of this month.
Authorities imposed a credit ceiling of 18 percent for banks for 2012 after Sri Lanka's monetary system ran into a balance of payments crisis largely due to excessive bank credit taken by state entities to manipulate energy prices.

"The growth of credit obtained by the private sector from commercial banks continued to decelerate, reaching 23.5 per cent (y-o-y), by October, from a high of over 35 per cent prior to March 2012," the Central Bank said.

"This growth is expected to decelerate further to around 19 per cent by end 2012."

Bank credit shot up from the second half of 2011 as the Central Bank injected tens of billions of rupees into banking system to sterilize foreign exchange sales driving imports to unsustainable levels.

But after interest rates and energy prices were raised and the exchange rate was allowed to fall in response to rupee injections from February 2012 credit started to fall off.

Official data shows that total bank credit to the private sector including dollar denominated loans fell from 155 billion rupees in the March 2012 quarter to 73 billion rupees in the June quarter and 69 billion rupees in the September quarter.

"The Central Bank has been carefully monitoring the developments in the various sectors of the economy vis-à-vis the projections for each of these sectors," the monetary authority said in its December policy statement.

"As per current information, a reasonable leeway has emerged between actual credit growth and the ceiling imposed by the Central Bank, indicating a further slowdown in credit utilisation.

"Economic activity has also experienced some moderation with adverse weather conditions and the uncertainty in the global economy exerting some pressure on growth in 2012."

Credit to the credit however still remained strong as taxes from imports fell amid excessive spending. Data showed state entities such as the road development agencies has become a big bank borrower outside the main budget deficit over the past year.

The rate cut came as inflation spiked to the highest level since 2009.

The Central Bank said inflation rose to 9.5 percent in November 2012 from 8.9 percent in October.

"However, as per current projections, inflation is expected to moderate towards the second quarter of 2013 and stabilise thereafter benefiting from the strong demand management policies introduced at the beginning of this year," the Central Bank said.

Sri Lanka has been prone to high inflation and balance of payments trouble ever since a so-called 'soft-pegged' exchange rate regime was created in 1951 abolishing a hard peg that had kept the exchange rate fixed and inflation low.

Sri Lanka has a failed Bretton Woods style peg designed by interventionist economics from Office of Monetary Research of the US Treasury.

Critics have pointed out that such pegs could generate very high levels of inflation regardless of the interest rate as foreign exchange operations, which created money outside the policy rate system, could either enhance or undermine the state policy stance.

Update II

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