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The Central Bank on Tuesday cut key short-term rates by 75 basis points in line with its policy of lowering lending rates.
The bank lowered the reverse repurchase rate (reverse repo) to 11 percent and the repurchase rate (repo) to 9 percent. These are the lowest rates since May, 2000. rn

rnThe Central Bank expects financial institutions to pass on the full benefit to customers, by reducing their lending rates, which would encourage investment in the economy and thus promote economic growth. rn

rnThe bank said the rate cut takes into account reductions in domestic market interest rates, excess liquidity, current and expected developments in inflation, stability in the foreign exchange market and movements in international interest rates.rn

rnThe change is also intended to further strengthen the recovery in economic activity. rn

rnThe rates were last tinkered on November 22, when the Repo rate was lowered by 75 basis points and the Reverse Repo rate by 100 basis points.rn

rnThe reverse repo-rate or the overnight reverse repurchase rate, is the rate at which primary dealers in treasury bills and commercial banks can obtain overnight funds from the Central Bank by pledging their treasury bill/bond holdings as collateral. rn

rnThe repo-rate is the key benchmark, which sets the floor in the overnight call money market, as it enables lenders to invest excess funds in treasury bills and bonds held by the Central Bank (i.e. at near zero risk). rn

rnIt is also the Central Bank quote s main instrument of signalling the expected direction of overall interest. rates to the marketrn

rnRecent economic developments have warranted a review of Central Bank quote s main policy rates. The excess liquidity in the market has led to a continuous decline in yields on government paper. rn

rnThree-month treasury paper has lost 98 basis points and the six-month notes by 156 basis points since the last reduction in Central Bank rates. rn

rnThe call money market has been highly liquid and the surplus in the market was around Rs. 12 bn at end 2002. rn

rnInflation has also decreased steadily in 2002. Measured by the 12-month moving average of the Colombo District Consumer Price Index (CDCPI), inflation, which declined from 10.3 per cent in December 2001, to 6.8 per cent in December, 2002, while on a point to point basis, it declined from 9.7 per cent to 4.5 per cent in the same period. rn

rnThe CDCPI showed a decline in inflation from November to December too, although the Colombo Consumers quote Price Index (CCPI) showed an increase. Inflation is expected to decline further in 2003.

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rnEconomic activity is gradually picking up from the recession in 2001. The first three quarters of 2002 have recorded increasingly positive growth, in contrast to the economic contraction experienced in the last three quarters of 2001.

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rnThe third quarter of 2002 recorded a growth of 5.3 per cent, in contrast to a contraction of 4.2 per cent in the corresponding quarter of 2001.

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rnThe government quote s resort to domestic borrowing has been contained, thus reducing pressure on domestic interest rates. rn

rnImproved Treasury cash management has reduced the government quote s overdraft with the two state banks from around Rs. 38 bn at the end of 2001 to a comfortable level of around Rs.

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4 bn at end 2002. rn

rnThe developments in the external sector too have been encouraging. The balance of payments recorded a surplus of US$ 122 mn in the first three quarters of 2002.

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The country quote s external reserve position has improved, with gross official reserves (excluding ACU liabilities) rising from US$ 1,200 mn (equivalent to 2.
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5 months of imports) at end December, 2001, to around US$ 1,510 mn (equivalent to about 3.1 months of imports). rn

rnThe foreign exchange market has been stable. The increasing activity in the forward market and declining forward premia reflect both improved perceptions regarding the stability of the market and an expectation of a further decline in domestic market interest rates. rn

rnThe rupee has depreciated against the US dollar by about 3.7 per cent in 2002, and by about 13-19 per cent against other major currencies such as the euro, pound sterling and yen, due to sharp cross currency movements. rn

rnAnnual monetary growth has been declining from a peak of 17.9 per cent in June and is expected to be around 14-15 per cent at end 2002. The growth of reserve money has remained well within the target. rn

rnInternational interest rates too have declined further recently. The US Federal Reserve Bank quote s benchmark, the Fed Funds rate was reduced by 50 basis points, from 1.75 per cent 1.25 per cent in November, following which the European Central Bank too reduced its Refinance rate by 50 basis points, from 3.

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25 per cent to 2.75 per cent in December. rn

rnMarket expectations are that there will be further reductions in major international rates early in 2003.rn

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