Sri Lanka Treasuries yields plummet after presidential ‘rate cut’

Oct 28, 2009 (LBO) – Sri Lanka’s Treasuries yields plummeted across the board Wednesday, a day after country’s president ordered a 700 basis point lending rate cut in state banks. The 3-month bill yield fell 60 basis points to 8.50 percent, the 6-month yield fell 41 basis points to 9.35 percent and the 12-month yield fell 34 basis points to 9.88 percent and into single digits.

The 3-month yield is now 50 basis points above the repo policy rate of 8.0 percent where excess money is parked in the Central Bank by banks, but far below 10.50 reverse repo rate at which money is injected to banks.

Due to persisted excess liquidity in the banking system in recent months, the repo rate had now become the effective policy rate in Sri Lanka.

The President ordered loans to be given at rates between 8.0 to 12.0 percent by state-run banks, ahead of national polls due early next year.

The effect of the on state bank balance sheets is not yet known.

Sri Lanka’s Central Bank has brought inflation down over the past year to low single digits, setting the stage for low interest rates in the country. But it had been treading cautiously in recent months as bad loans mounted in banks.

Sri Lanka’s interest rates rose in the past few years due to massive deficit spending and high inflation created by fiscal dominance of monetary policy.

The main reason for Sri Lanka’s high interest rates is fiscal indiscipline, where most of the people’s savings are taken by the government.

The government has run a current account deficit and borrows to finance all capital expenses.