Sri Lanka Newspapers 04/02/2012

Decline on CSE continues during half-day’s trading
*Bourse closes week on negative note

The Colombo bourse yesterday closed the week with an abbreviated trading day with both indices down and turnover a modest Rs.419.9 million, down from the previous day’s Rs. 970.1 million, brokers said.

Trading ended at 12 noon after two-and-half-hours as the CSE worked for only half the day on account of the Independence Day holiday today.

The All Share Price Index was down 19.10 points (0.34%) and the Milanka down 27.99 points (0.58%) with 40 gainers strongly outpaced by 119 losers.

Business volumes were supported mainly by Commercial Bank, Distilleries and ERI warrants which traded for the last time yesterday on an SEC directive.

Commercial Bank closed Rs.1.20 down at Rs.100.50 with nearly 1.5 million shares traded between Rs.100.10 and Rs.101.10. Although there were no crossings, some big parcels were done at Rs.100.50, brokers said.

Distilleries closed 80 cents down at Rs.135 on nearly 0.2 million shares done between Rs.132.50 and Rs.135. Here too there were no crossings but a parcel of 94,800 shares was done at a price of Rs.132.50 and two other parcels of 62,000 and 16,000 done at Rs.135.

Over 6.9 million ERI warrants (W0002) were traded yesterday gaining Rs.1.30 to close at Rs.3.20 having traded at Rs.1.40 and Rs.5.

Swarnamahal continued to gain closing Rs.2.60 up at Rs.157 on slightly over 0.1 million shares traded between Rs.155 and Rs.161 while JKH edged down 30 cents to close at Rs.168.70 on 90,000 shares done at Rs.166 and Rs.168.90.

ERI gained Rs.1.10 to close at Rs.27.30 on nearly 0.6 million shares done between Rs.25.60 and Rs.27.50.
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*Ceiling imposed on bank credit growth

With the country staring down a balance of payments crisis which saw Central Bank intervention in the foreign exchange market erode the reserve position and wipe out rupee liquidity already under pressure from growing credit demand, the Central Bank finally admitted there was a serious problem and yesterday announced an increase to policy interest rates and slapped limits on commercial bank credit growth in a bid to curb demand.

The Central Bank also allowed the rupee to fall 20 cents to a dollar. The exchange rate which was kept at Rs. 113.89/90 to dollar was allowed to increase to Rs. 114.10, dealers said yesterday.

The Central Bank said the repurchase rate would be increased by 50 basis points to 7.50 percent and the reverse repurchase rate also by 50 basis points to 9 percent. These two rates apply to commercial bank deposits with and borrowings from the Central Bank.

The Central Bank has also slapped a ceiling on commercial bank credit growth of 18 percent and 23 percent if the balance 5 percent comes from foreign sources.

Releasing its Monetary Policy Review for February 2012, the Central Bank said: "Consequent to the increased domestic economic activity, low interest rates, as well as the unexpectedly high energy prices in the international market, the total expenditure on imports increased substantially to US dollars 18.4 billion during the first eleven month of 2011 widening the trade deficit. This was in spite of earnings from exports increasing by 22.2 per cent to US dollars 9.6 billion during the period. Increased earnings from tourism, increased workers’ remittances, and other inflows to the services account helped cushion the impact on the current account deficit, while the Central Bank had to intervene by supplying foreign exchange, on a net basis, to mitigate the undue pressure on the domestic foreign exchange market.

"As a result, despite higher inflows of foreign direct investments and inflows to the Government, gross official reserves (excluding Asian Clearing Union balances) declined to US dollars 5.9 billion by end December 2011, representing the equivalent of 3.6 months of imports.

"Meanwhile, credit granted by commercial banks to the private sector increased by 34.5 per cent, year-on-year, in December 2011, substantially exceeding projections. Provisional estimates indicate that within the credit extended to the private sector by commercial banks, trade related credit and credit driven by import related items such as motor vehicles and consumer durables increased significantly. Import related credit increased by over 34 per cent during 2011, while the increase in credit for export activity was only around 8 per cent during the year. Pawning also displayed a significant increase in 2011. In addition, credit granted to the Government and public corporations by commercial banks increased considerably, and in particular, a higher petroleum import bill and the inadequate adjustment to domestic petroleum prices led to increased borrowings by the Ceylon Petroleum Corporation (CPC)," the Central Bank said.

"At the same time, excess liquidity in the domestic money market declined from Rs.124 billion as at end 2010 to the current level of around Rs 15 to 20 billion, and such decline in liquidity in the domestic money market led to market interest rates recording an upward movement in recent months. With excess liquidity declining, commercial banks also competitively raised interest rates paid on deposits, with rates on 3-month and 6-month term deposits showing a considerable increase during the past few months.

"Taking into consideration these macroeconomic developments, the Monetary Board of the Central Bank of Sri Lanka is of the view that the continuous increase in credit extended to the private sector by commercial banks needs to be addressed for two main reasons: First, to curtail import related credit, thereby reducing the trade deficit and the current account deficit, and second, to effectively ensure that inflation remains at the mid-single digit levels in the second half of 2012 as well, notwithstanding the sharp build up of credit in 2011.

"Accordingly, the Monetary Board, at its meeting held on 2nd February 2012, decided to increase both the Repurchase rate and the Reverse Repurchase rate of the Central Bank by 50 basis points each. Hence, the Repurchase rate and the Reverse Repurchase rate of the Central Bank will be 7.50 per cent and 9.00 per cent, respectively. The Monetary Board also decided to direct commercial banks to moderate their credit disbursements so that the overall credit growth in 2012 will not exceed 18 per cent of their respective loan book outstanding at the end of 2011, while credit growth of up to 23 per cent will be allowed for those banks, which finance the excess up to 5 per cent of the credit growth, from funds mobilised from overseas.

"In addition, the Central Bank will monitor on a regular basis, the targets for inflows as set out in the "Road Map: Monetary and Financial Sector Policies for 2012 and beyond", with regard to foreign direct investments (FDI), earnings from tourism, workers’ remittances, Tier 2 capital of banks, inflows to the stock market, inflows to the government securities market, and a credit line for petroleum imports, which would help increase net foreign exchange inflows to the country, thereby enabling the balance of payments to record a healthy surplus in 2012. The Monetary Board is of the view that these adjustments to the monetary policy stance of the Central Bank, as well as other measures that may be adopted by relevant Government authorities would materially reduce the need for the Central Bank to supply foreign exchange to the market, on a net basis, during 2012.

"Inflation, as measured by the change in the Colombo Consumers’ Price Index (CCPI, base 2006/07), continued to moderate, with year-on-year inflation declining to 3.8 per cent in January 2012 from 4.9 per cent in December 2011. While this is the 36th consecutive month with single digit inflation, improvements in domestic food supplies such as most varieties of vegetables, potatoes and big onions mainly contributed to the continuation of low inflation, whereas non-food inflation showed an increase during the month. Meanwhile, year-on-year core inflation in January 2012 remained unchanged from the previous month at 4.7 per cent," the Central Bank.

The date for the release of the next regular statement on monetary policy will be announced in due course.

US$ 1.56 billion was used up from the reserves to artificially prop up the rupee during the four month period July to October 2011. According to dealers, a further US$ 1 billion has been sold to-date since the rupee was depreciated by 3 percent in November 21. By end November 2011 reserves stood at US$ 6.2 billion, down 30.6 percent from US$ 8.1 billion in July, with the borrowed component now becoming more significant as the reserves diminish, shrinking the comfort zone.

According to our calculations, for the past one and a half months, the Central Bank has pumped in a total of almost Rs. 300 billion to ease the rupee liquidity tightening which was caused by the dollar sales. The drain on rupee liquidity has resulted in some banks finding it difficult to maintain favourable overnight balances.

Fitch Ratings also said the loans-to-deposits ratio of the banking sector was falling with smaller banks reaching 100 percent, an indication that liquidity was tight.
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*Says Sri Lanka facing challenges of successful economy
*Govt. and IMF reach ‘common understanding’
*US$ 2.6bn SBA programme can be concluded successfully with or without govt. deciding to draw last two tranches

The International Monetary Fund (IMF) is satisfied that Sri Lanka is taking measures to adopt a package of flexible policies that would help the economy respond to challenges arising out of the post-conflict economic success.

IMF Sri Lanka Mission head Dr. Brian Aitken, speaking to journalists last afternoon, said a common understanding had been reached during discussions with the government on measures that would have to be taken to counter the expanding trade deficit, drop in official dollar reserves and growing credit.

The Central Bank last morning releasing its Monetary Policy Review for February 2012, announced an increase to key policy interest rates by 50 basis points and a ceiling on commercial bank credit growth to 18 percent, which could be moved up to 23 percent if the balance would be funded from foreign sources.

This was intended to curtail excessive credit growth which was fuelling import demand. The Central Bank had been selling dollars to keep the exchange rate stable which resulted in the IMF not concluding the previous review. These dollar sales not only depleted reserves but also drained rupee liquidity in the market. The Central Bank in turn had to print money to keep rupee interest rates in check, which only fuelled credit demand even more which fed import demand, and the cycle continued for months.

Although not as bad as it was in 2009, the country was heading towards a balance of payments crisis.

The Central Bank had consistently said that they would not allow the rupee to depreciate and that interest rates would be maintained at low levels. However, the Treasury has been calling for a more flexible exchange rate and tightening of interest rates.

"The economy is growing quite rapidly and inflation is under control. Exports and remittances have been strong during the last quarter of 2011, however imports grew much faster than expected mainly driven by consumer, intermediate and investment goods associated with a growing economy. We had expected the expansion of the trade deficit and credit growth to slow down but this has not happened. These are the challenges faced by a successful economy," Dr. Aitken said.

The IMF was satisfied with the measures announced by the Central Bank to curb credit growth.

"We see this as the first step in the right direction. It is also one piece of the several pieces of a policy package we would like to see unfolding going forward, to which the government expressed its commitment. We believe the government is now beginning to address the aberrations experienced in the previous quarter. Flexibility is required in the monetary policy, exchange rate policy and fiscal policy. It is too early to comment as to how effective these measures would be but we believe the government is moving in the right direction," Dr. Aitken said.

He said that Sri Lanka could still successfully complete the US$ 2.6 billion standby arrangement facility but it was up to the government to decide whether it would draw the last two tranches amounting to US$ 800 million.

"Once a review is completed successfully funds are made available to a country. However, it is up to governments to decide whether to draw the funds or not, we have no agreements on this."

The IMF said the country’s reserves declined markedly and that it distinguished between borrowed and non-borrowed reserves, a fact many central bankers had denied in the past.

"The tranches are mainly meant to boost reserves, but there is no restriction on how it is used," Dr. Aitken said in response to a question whether IMF funds could be used to repay debt.

Drawing the balance tranches would incur an additional 2 percent surcharge on top of the 1.1 percent already charged on the US$ 1.7 billion drawn, but this 3.1 percent interest would not apply to the entire US$ 2.6 billion, only to the last tranches.

This means, it would still be cheaper for the government to go ahead with the IMF programme and draw the remaining tranches which would be cheaper than the commercial rates applicable to a sovereign bond, at more than 6 percent.

Central Bank Governor Ajith Nivard Cabraal last week said it would not be necessary to draw the last two tranches of the programme as it became increasingly clear that the IMF would not accommodate an inflexible exchange rate regime.

The IMF issued the following statement at the end of its review mission on Friday (Feb. 03):

"A staff mission led by Dr. Brian Aitken visited Colombo January 25 – February 3 to discuss economic developments and policies. The team met with government and Central Bank officials, as well as representatives of civil society and the private sector. The team issued the following statement today at the conclusion of its visit.

"The economy continued to expand rapidly in 2011, with growth likely to come in around 8 percent, and inflation continued to moderate to solid mid-single digit levels. The Government budget deficit also declined further, to under 7 percent of GDP. However, a strong rebound in domestic demand, supported, in part, by increased bank lending, resulted in a larger than anticipated surge in imports, causing the current account deficit to widen significantly in 2011, despite healthy growth in exports and remittances. External reserves declined markedly in the second half of 2011.

"The discussions focused largely on the government’s strategy to address the external imbalances that emerged in the second half of 2011 and ensure that the economy’s recovery continued without undue disruption. There was broad agreement that a decisive policy response was needed to put the economy on a sounder macroeconomic footing, especially given the current uncertain global environment. In this context, we are encouraged by the recent adjustments in the monetary and exchange rate policy stance, as well as the strong commitment of the government to further reduce the budget deficit to 6.2 percent of GDP in 2012 and address the losses of key state owned enterprises.

"The team will return to Washington and continue to assess policy actions and economic developments. We look forward to moving toward completion of the next review of the Standby Arrangement."
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