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Tue, 23 September 2014 11:17:33
Sri Lanka policy rates steady, market rates up
11 Jan, 2012 08:10:46
Jan 11, 2012 (LBO) - Sri Lanka's main policy interest rate at which cash is injected to the market will remain at 8.50 percent but an increase in market rates could help reduce money supply growth, the Central Bank said as it battles pressure on a dollar peg.
Sri Lanka's peg with the US dollar was pressured from the second half of 2011 due to high credit growth, which was financed with excess reserves which accumulated during a period of low credit expansion.

The central bank in it January monetary policy statement said broad money grew (M2b) grew 20.6 percent in November, though market rates moved up over the past few months.

Rates moved up due to liquidity shortages coming from the defence of a dollar peg.

Sales of dollars by the Central Bank results in an equivalent reduction in rupee liquidity, and to keep rates from spiking immediately the Central Bank injects fresh liquidity by printing money to 'sterilize the interventions."

Despite the sterilizations one year Treasury bill yields rose 175 basis points, the average weighted prime lending rate (AWPR) increased by around 120 basis points in 2011 and the average weighted deposit rate (AWDR) rose 100 basis points, the Central Bank said.

Analysts say higher deposit rates will help reduce aggregate consumption and provide deposits to finance credit growth. Higher lending rates can also reduce credit growth, allowing the monetary system to rebalance.

But credit to business by November was up 33.5 percent from a year earlier, the Central Bank said. In October credit growth was up 33.4 percent.

Rates rise because sterilizations are less than 100 percent and analysts say expansionary sterilizations give additional reserves for banks to lend, keeping credit growth and imports high. To break the cycle of interventions and sterilization, the currency has to be floated.

If liquidity injections are 100 percent, rates can be held but reserve losses could increase, analysts. The Central Bank said Treasury bill auction rates were steady for two weeks running.

By December 2011, Sri Lanka's forex reserves have fallen to 6.0 billion US dollars from a 8.0 billion dollar high amid sterilized interventions.

The central bank said in 2012 tourism earnings is expected to be 1.2 billion US dollars, migrant worker remittances would be 6.5 billion US dollars and foreign direct investments would increase to 2.0 billion US dollars.

The inflows will increase the spending power of the domestic economy, boost economic activity (growth) driving imports and the trade deficit.

Updated

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READER COMMENT(S)
3. kawdaboy Jan 11
Sterilization depends on the quantum of rupees released by the central bank as against foreign currency aka USD released to the economy.
2. fuss Jan 11
Econ Student
You are right. If sterilized intervention (to defend a peg) is called 'accommodated intervention' the effect will will be clearer and people will be readily able to distinguish the problem and avoid BOP crises.

In an 'accommodated intervention' (termed expansionary sterilization here) the central bank sells dollars, buys rupees and sells rupees again (buying T-bills).

In a contractionary sterilization, so labelled, a central bank buys dollars, sells rupees and buys rupees again (selling down its bill stock).

These are completely different transactions one with a contractionary effect and the other expansionary. In the former upward pressure is caused on the peg due inflows being prevented from being used by the banking system for credit. In the latter, fresh reserves are created to lend. In popular terminology in use in literature is 'sterilized intervention' for both cases and money market transactions are involved in both case. We can call it non-accommodated intervention.

But then we also need another term to describe the situation where the the effect is contractionary when money markets are involved.

Essentially there are four types of interventions, but their effect on the economy can only be measured by the final changes to the balance sheet of the central bank and by extension the economy.

This terminology problem may also be one reason why soft-pegged central bankers create balance of payments crises again, and again, and again....

1. EconStudent Jan 11
The appropriate term to describe the situation in hand is not 'sterlisation', but 'accommodation'; sterlisation means taking the money in circulation in the system back to CB and hiding it; when the CB sells dollars to support the exchange rate, money flows back to CB causing an unintended sterlisation. When CB issues new money to replenish the sterlised amount, it simply accommodates the needs of the system. Hence, it should be termed expansionary accommodation and not expansionary sterlisation.