COLOMBO: Sri Lanka will narrow its policy corridor further giving tighter control over short term rates to the rate to the Central Bank to control benchmark interest rates, rate setting monetary board, Deputy Governor Nandalal Weerasinghe said.
“When we move into an inflation targeting regime we would like to have a narrower band to manage interest rates,” Weerasinghe said.
“So whenever there is an opportunity for us to revise the rates, we would be revising with that in mind.”
The gap between Sri Lanka ceiling policy rate at 8.75 percent and the floor at 7.25 percent was narrowed to 150 basis points with a 25 basis point cut on the ceiling rate on April 04.
Sri Lanka’s active policy rate until a week ago was the floor rate with market rates halted from falling further by the standing deposit rate window.
Whenever credit slows and the central bank buys dollars generating liquidity (also sterilizes the forex purchases mopping up excess liquidity) overnight money market rate tends to move towards the floor without an overt rate cut.
Whenever credit picks up, and especially if the central bank then sells dollars to defend the currency generating liquidity shortages, which are then filled overnight through is reverse repo window, generating balance of payment crisis, rates moves towards the ceiling rate.
Through reverse repo auctions the rate can be kept lower than the ceiling, (in the middle of the corridor) worsening imbalances during periods of strong credit growth. With repo auctions rates can be kept higher than the floor, worsening a downturn after credit slows.
Analysts have pointed out that a wide corridor allows market rates to move towards the equilibrium rate without a formal decision of the monetary board.
In a central bank a monetary board – a bureaucratic panel which some critics describe as a politbureau – tries to second guess the market equilibrium interest rate.
