Thursday, December 7, 2023

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Central Bank compels to reduce interest rates after the horse bolted

Sri Lanka market rates on longer-term government debt – bonds and treasury bills – are about twice as high as the high policy rates for overnight money, increasing the government’s burden in covering its budget deficit and refinancing maturing debt, several economic analysts said.

“If an appropriate downward adjustment in the market interest rates would not take place in line with the envisaged disinflation path, the central bank will be compelled to impose administrative measures to prevent any undue movements in market interest rates,” CBSL said in a statement.

The island nation has been struggling with soaring inflation, partly triggered by its worst financial crisis in seven decades and an ill-considered ban on chemical fertilisers implemented last year and since reversed.

Central Bank threatened administrative intervention to control high market interest rates that it regarded as out of line with the inflation outlook.

Any such action, interpreted by economists as meaning it might push market rates down, would lower the government’s high borrowing costs.

However, it was unclear how the central bank could force investors to support public finances at lower rates than they expected.

Well known banker, eminent economist and Board of Investment (BOI) chairman Dinesh Weerakkody said that h igh interest rates increase the cost of borrowings, reduce disposable income and thereby limit growth in consumer spending and business expansion.

When the cost of money in the form of interest rates rises rapidly, growth may slow down sharply or even give way to a contraction in the economy, with the risk of business bankruptcies.

With higher interest rates taking hold, borrowers should expect to pay more for business loans and consumers to pay more for medical loans, car loans, credit cards, and housing loans he said adding that indeed, a rising interest rate environment impacts consumers alike whether they are net borrowers or net savers – the former more than the latter.

How ever he pointed out that the positive side of high interest rates are they tend to reduce inflationary pressures and cause an appreciation in the exchange rate.

But Sri Lanka’s recent spike in inflation was largely driven by a man-made forex crisis from an artificially overvalued currency used to defend it, and thereby depleting its meagre usable foreign reserves. As a consequence we imported inflation, he claimed

The high interest rates have hit the middle and lower class right in the belly and negatively impacted the SMEs and now the organised private sector, he added.

With the instinct of all ways reversing the monetary policy after causing the damage, Governor of Central Bank Nandalal Weerasinghe disclosed recently that steps will be taken in 2023 to reduce key interest rates in Sri Lanka

Weerasinghe told media that inflation is also expected to fall in 2023 and Sri Lanka’s inflation rate eased to 57.2 per cent in December from 61 per cent in November, noting that this reflected that the policies they have taken from April 2022 were successful.

High interest rates have kept inflation down but the rates will be reduced as the economy stabilizes, he said.

Sri Lanka’s central bank in November 2022 decided to maintain the Standing Deposit Facility Rate and the Standing Lending Facility Rate at the levels of 14.50 per cent and 15.50 per cent, respectively.

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