Dealers said Central Bank’s attempts to persuade commercial banks to cut interest rates immediately and increase lending to a credit starved economy is futile given the current financial situation of the country.

Last week the Central Bank issued a press release where it said credit to the private sector had declined to 6.4 percent in January 2009 from 7.9 percent at end 2008; notwithstanding measures it took to release more liquidity into the money market.

The Central Bank over the past few weeks had taken several steps to ease its monetary policy stance so as to infuse more liquidity into the economy.

The penal rate of interest imposed on reverse repurchase transactions with the Central Bank was reduced gradually from its initial rate of 19 per cent to 14.75 per cent.

The Repurchase and Reverse Repurchase rates have also been reduced by 25 basis points each to 10.25 per cent and 11.75 per cent, respectively.

The Statutory Reserve Ratio (SRR) applicable to rupee deposit liabilities of commercial banks has been reduced by a total of 300 basis points to 7 per cent, by January 2009.

The Central Bank said that liquidity shortfalls of commercial banks have been addressed through its open market operations on a daily term and permanent basis.

"The average call market rate currently is around 12 per cent compared to 17-19 per cent that prevailed prior to the relaxation of monetary policy and yield rates on Treasury bills and bonds have declined in a range of 170 – 240 basis points since end 2008," the Central Bank said last Friday.

Poor response…

"However, we notice with concern, that commercial banks have not yet responded sufficiently to the easing of the monetary policy stance of the Central Bank and accordingly, the Central Bank has requested commercial banks to enhance lending activities immediately," the Central Bank said in its statement.

Cannot force…

Dealers said that the Central Bank’s request to immediately bring down lending rates and increase lending to the private sector is reasonable but not practical.

"The Central Bank will first have to try and convince state banks to bring down their deposit rates so that commercial banks too can bring down deposit rates and in turn gradually bring down lending rates," a dealer said.

Banks are in stiff competition for public deposits and higher the interest rates more deposits are collected which are in turn lent.

"Each bank sets its interest rates independent of each other, but rates of other players do influence the process because at the end of the day any bank would like to attract as many deposits as possible,

"Lending rates are set based on the deposit rates to which a margin is added. Unlike the exchange rate which is uniform and the Central Bank can exert control, interest rates on the other hand cannot be controlled," he said.

However, the extent of the margin is often questioned and criticized by the private sector, especially the SME sector.

"Credit is given to those who least need it," is an often quoted statement by many in the business world.

Another dealer said that many term deposits have high interest rates which cannot be revised downwards until they mature.

"So an immediate response to Central Bank’s request is not possible at this stage," another dealer said.

Preferential treatment…

However, dealers said that only selected clients are enjoying the benefits of the measures taken by Central Bank.

"It is clear that the Central Bank has been, and is, trying to bring down lending rates in a bid to stimulate the economy.

"For now, however, these measures have only allowed us to service selected customers who maintain credit quality. Perhaps if things improve further banks may be able to bring down rates across the board," a dealer said.

"At the moment contraction in lending has little to do with the availability of credit than the credit worthiness issues of those we lend to," he said.

A crisis in confidence…

Dealers said the global financial crisis and Sri Lanka’s own problems has caused a crisis of confidence.

"Banks are unwilling to lend to each other let alone lend to elements in the economy that do require credit," a fund manager said.

Speaking on the basis of anonymity he said the government was the biggest borrower from the domestic sector, especially now with foreign credit squeezed because of the global financial crisis.

"When the market determines interest rates any attempt to artificially control them cannot be sustained in the long run and somewhere down the line it would require a painful adjustment," he said.

Apprehension…

Meanwhile, dealers said there was growing apprehension about the fate of the exchange rate with regards to the IMF facility for US$ 1.9 billion currently being negotiated.