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UPDATE 1-Sri Lanka keeps rates steady to spur more loan demand

[Reuters, Tuesday, 19 January 2010 11:41 No Comment]

Sri Lanka’s central bank kept interest rates unchanged for a second straight month on Tuesday, hoping more loan demand from the private sector will fuel a solid post-war economic expansion.

The economy is expected to expand by more than 6 percent this year after having hit an eight-year low of 3.5 percent in 2009, with policymakers hoping the end of the island’s 25-year-civil war last year will produce a strong peace dividend in the form of increased investment.

The central bank kept its repurchase rate at a near five-year low of 7.50 percent after cutting it 3 percentage points in 2009 to cushion the economy from the worst of the global financial crisis.

The reverse repurchase rate stands at 9.75 percent, its lowest in more than four years after the bank cut it by 2.25 percentage points last year.

"As a result, credit to the private sector, which contracted continuously during the period from January to October 2009, indicated a positive turnaround in nominal terms in November," the central bank said in a statement.

Further growth in private sector credit is expected as broader economic conditions improve, the central bank said. Central Bank Governor Ajith Nivard Cabraal said on Jan. 1 that the Monetary Board would take a cautious approach in relaxing policy rates further, since the market has yet to fully react to last year’s rate reductions. [ID:nSGE5BT01U]

The weighted average prime lending rate is at 10.79 percent, but average bank lending rates are still around 15 percent.

"The central bank is in a catch-22 situation," said one analyst on condition of anonymity.

"There is no room for market lending rates to come further down unless the policy rates are reduced. At the same time, the central bank can’t raise the rates despite inflationary expectations, (as it wants to) prevent hot foreign money coming in." Some analysts said the cautious decision was to prevent sending out different signals to the market ahead of a presidential election on Jan. 26.

Annual inflation hit a nine-month high of 4.8 percent last month from 2.8 percent in November, due to a low base effect and rising food prices. It hit a record low of 0.7 percent in September.

The central bank expects inflationary pressures to be benign this year, with the inflation rate seen remaining in the single digits through to year-end.

Investor confidence in the $40 billion economy surged after the end of the war in May, attracting foreign investments into government debt and both listed and unlisted companies on hopes of a rapid post-war recovery.

[Full Coverage]

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