By Yakuta Dawood
Recently, the Central Bank of Sri Lanka (CBSL) imposed a maximum interest rate of 5% for foreign currency deposits of licensed commercial banks (LCBs) and National Savings Bank (NSB).
This topic is important because this CBSL measure will now eliminate the interest rate anomaly that prevailed in the domestic market between interest rates offered by banks on foreign currency deposits and rupee deposits.
Responding to our email query, CBSL Secretary to the Governor Erandi Liyanage stated that by this implementation, CBSL expects that it will encourage more foreign currency earners to convert their receipts into rupees, thereby contributing to further improve foreign currency liquidity in the domestic foreign exchange market.
Before the implementation of a 5% ceiling on exporter dollar deposit rates, the interest rates offered on foreign currency deposits by domestic banks were observed to be much higher than their corresponding international average interest rates, while some banks were offering rates even higher than the corresponding rupee deposit rates.
“This anomaly affected foreign currency liquidity in the domestic forex market, as foreign currency earners preferred to hold foreign currency, given the higher returns. In this context, the purpose of this measure was to address the above interest rate anomaly between foreign and domestic currency deposits,” Liyanage mentioned.
Releasing a press release with regard to this subject, CBSL, on 24 August, stated that the maximum interest rate offered or paid by an LCB and NSB on all foreign currency deposits shall not exceed an annual effective rate of up to 5%. However, in the case of special deposit accounts (SDAs), the interest rate can be above this rate.
Local banks’ response
The Sunday Morning Business spoke to several commercial banks to get their expertise on this timely subject. Speaking to us, Commercial Bank of Ceylon PLC Chief Financial Officer (CFO) Nandika Buddhipala stated that the effectiveness of this measure will depend on how consumers are going to take it up, their speculative perception, the availability of the dollar, and the interest rate preferential in the rupee and the dollar.
“It is a bit too early to comment on the effectiveness of this implementation. We will have to wait and see the behavioural pattern of how consumers will react to this, because there will be people with different objectives, perceptions, and ways of thinking,” Buddhipala explained.
He stated that since the exchange rates are depreciating compared to what it was earlier, the customers who have savings in dollars or any other currency terms would now start to welcome this implementation initiated by CBSL.
We also spoke to Bank of Ceylon (BOC) Chief Manager – Treasury Nadira Jeewantha who stated that this is a good move by CBSL, since it will keep the deposits, especially of export earners, in one bank, rather than them constantly switching their deposits from one bank to another depending on the rate of return.
“All banks will now have the same interest cap for foreign currency deposits, meaning it will help one bank to keep their deposits rather than allowing exporters to transfer cash into other banks that have a high interest rate,” Jeewantha said.
Expressing similar views, BOC Deputy General Manager – Corporate and Offshore Banking W.N.P. Surawimala also stated that this is a good move by CBSL, as the industry did not benefit prior to this implementation.
However, Sampath Bank was not able to comment at the time of going to print, and all attempts to reach People’s Bank and National Development Bank (NDB) proved futile.
Other policy measures implemented by CBSL
With the view of addressing the imbalances in the external sector, CBSL on 6 August decided to increase the Standing Deposit Facility Rate (SDFR) and the Standing Lending Facility Rate (SLFR) of the Central Bank by 50 basis points each to 5.00% and 6.00%, respectively.
Along with that, in order to tighten the Monetary Policy Stance, with effect from 1 September, the Monetary Board increased the Statutory Reserve Ratio (SRR) applicable on all rupee deposit liabilities of LCBs by 2.0% points to 4.00%.
“The Board expects these monetary policy decisions to iron out the prevailing imbalances in the domestic financial markets and the external sector of the economy, while preempting the build-up of any excessive inflationary pressures over the medium term, thereby supporting greater macroeconomic stability,” CBSL noted.
With regard to the interest rate, CBSL stated that due to the low-interest environment in Sri Lanka, credit to the private sector has expanded prominently during the first half of 2021, surpassing the annual expansion of credit observed in 2019 and 2020.
“The upward adjustments in market interest rates and the expected liquidity deficit in the domestic money market would also help the economy to absorb the large amount of currency held by the public observed since the onset of the pandemic in early 2020,” the CBSL report further said.
However, CBSL added that even with limited conversion by exporters and the advancement of imports, together with some speculative activity, prompted by anomalies between interest rates on the rupee and foreign currency products in the financial market that exerted undue pressure on the exchange rate in the domestic market, CBSL was still able to meet all debt service obligations of the Government on time, including the settlement of the International Sovereign Bond (ISB) of $ 1 billion in late July 2021.
With reference to the estimates published by the Department of Census and Statistics (DCS), the economy has witnessed a stronger-than-expected recovery during the first quarter of 2021, thereby recording a real growth of 4.3% Year-on-Year (YoY).
Reflecting on this, the CBSL report mentioned that the economy is poised to record a higher growth rate during the second quarter of 2021, with projections suggesting that the real economy would grow over 5% in 2021 due to the sharp contraction observed in the corresponding quarter of the previous year.
“Possible disruptions to domestic economic activity from the re-emergence of the Covid-19 pandemic and related preventive measures could weaken the recovery to some extent during the second half of 2021. Nevertheless, with the successful rolling out of the national Covid-19 vaccination programme and the Government’s strategy to impose only selective mobility restrictions, the momentum of activity is expected to sustain in the period ahead,” CBSL added.
Addressing foreign reserve pressure
Regardless of previous attempts to curtail the foreign reserve issue, Sri Lanka did struggle to preserve or improve its reserve position while the country’s import cover was on a downward trajectory, ICRA Lanka reported, releasing its mid-year economic update.
Speaking to us earlier this month, former CBSL Deputy Governor Dr. W.A. Wijewardena stated that the reserves position in Sri Lanka has fallen to a critically low level of about $ 2.8 billion, for which the country has to economise the use of foreign exchange until the better and larger inflow.
Dr. Wijewardena, via his Twitter, shared: “The Central Bank had sold 13 tonnes of gold in February and may be tempted to sell balance six tonnes to increase liquid forex; it’s done, no more gold; and the promised SDR allocation by the IMF in August will increase reserves to $ 3.6 billion.”
He further said the country is battling with the deadliest Covid-19 variant and that the Government has to seek immediate foreign aid measures to stabilise the country’s failing economy.
“Situation is getting alarmed day by day like rising Covid-19 cases; Finance Minister Basil Rajapaksa should come up with a viable plan immediately to convince the international community that we’re making progress in the correct direction; otherwise, no choice but crunch imports further (sic),” his Twitter post added.
Meanwhile, State Minister of Money, Capital Market, and State Enterprise Reforms Ajith Nivard Cabraal, speaking to The Sunday Morning Business, said that several Opposition groups have been making speculations about Sri Lanka’s foreign reserve level and attempting to convey a status of instability.
“At the moment, there is an economic challenge before us with the reduction in the number of our foreign reserves. But it started during the previous Yahapalana Government’s period. However, I must say that it is not at an alarming level,” he said.
However, he added that with the scheduled inflows over the upcoming months – such as swaps from India and Bangladesh, inflow from International Sovereign Bonds (ISBs) held by local banks, and the loan from China Development Bank – the country’s forex pipeline would be upgraded with nearly $ 2,650 million in the upcoming months.
“This can be accessed and hence could be included as part of its effective reserves. In addition, arrangements are being made to roll over almost the entirety of the Sri Lanka Development Bonds (SLDB) and Foreign Currency Banking Unit (FCBU) loans that are maturing over the balance part of the year. So, these maturities will not lead to a reduction in the reserve,” he added.