The Central Bank further relaxed its monetary policy stance in a bid to expand the growth of credit to stimulate the country’s economy.

Dealers said was a clear direction to the market that the Central Bank wanted lending rates to come down.

The Central Bank yesterday removed the penal rate of interest on reverse repurchase transactions while reducing the rate by 25 basis points to 11.5 percent. It also removed restrictions on the number of times commercial banks can access the reverse repurchase window of the Central Bank as the lender of last resort.

The reverse repurchase window allows commercial banks to borrow from the Central Bank by surrendering Treasury bills and bonds whenever raising funds in the money market is difficult.

When inflation was high the Central Bank limited access to this window to three times a month with a rate of 11.75 percent, and a penal rate of 13.75 percent was applied each time banks exceeded this limit.

The Central Bank has now removed all these restrictions and only an 11.50 percent reverse repurchase rate would apply.

"This is a clear direction from the Central Bank that it wants banks to reduce their lending rates because banks have easier access to credit from the Central Bank and this should help bring down lending rates further," a dealer said.

Earlier, the penal rate for reverse repurchase transactions, at 13.75 percent, had been the benchmark for lending as it was the lowest rate for banks’ to borrow when they could not do so in market. Now it is down to 11.50 percent.

"Market interest rates have begun to show a gradual decline in response to the relaxation of monetary policy and the measures adopted by the Central Bank to safeguard financial system stability. It is expected that the Central Bank relaxing its monetary policy stance further would aid market interest rates to decline further, lowering the cost of borrowings and spurring economic activity," the Central Bank said.

The Central Bank said the country is now poised to enter a promising era after the war on terror but it would be economically challenging.

"Sri Lanka is poised to enter a more promising, yet economically challenging era. Growth prospects in 2009, which were dampened by the global downturn in economic activity, have now brightened. Rising domestic demand along with the reconstruction and development of areas liberated will help expand domestic production and thereby add to the country’s output," it said.

However dealers said the banking system has a lag effect of four and a half months because of the high cost of funds in terms of high interest paid on long term deposits.

With the Central Bank’s latest relaxations, banks can now borrow at 11.50 percent anytime they want. The interbank rates are 10.82 percent for overnight transactions while rates for a month and three months stand at about 12.75 percent and 13.65 percent respectively (as at Thursday morning). These are the rates banks can borrow at.

But the average weighted prime lending rate (AWPR) of commercial banks is at 18.27 percent. This is an indicative rate of banks’ lending rates for loans to the public.

According to one dealer the AWPR, which is an average of average lending rates of commercial banks published weekly by the Central Bank, is manipulated.

"The AWPR is skewed because some banks manipulate their data. The average lending rate that is applicable to the AWPR is the average rate of three month facilities offered to high profile customers. But this is not the data that seems to be coming in," he said.

Indeed, dealers say the high profile customers have been able to enjoy reduced borrowing rates over others.

As at 15 May, out of 22 commercial banks, 16 of them had an AWPR below 20 percent, five of them below 18 percent.