Finance ministry would issue a circular directing state banks to cut lending rates and there was a possibility of private banks being also directed to cut lending rates through the island’s monetary authority, a government minister said.

Sri Lanka’s powerful president Mahinda Rajapaksa ordered state bank to cut lending rates by 700 basis points to between 8.0 and 12.0 percent last week.

State revenue minister Ranjith Siyambalapitiya told reporters Friday that a circular would be issued before November 03 to state banks detailing the way rates should be cut.

"We expect that private banks would follow suit," Siyambalapitiya said.

Though the government had no intention to de-stabilize private banks, he said there was a possibility of government intervention through the monetary board or the governing body of the island’s central bank.

The original presidential order came following a meeting at which Siyambalapitiya and Treasury Secretary P B Jayasundera, who is a member of the rate setting monetary board of the Central Bank.

Sri Lanka’s current economic woes, where a housing and financial bubble collapsed in addition to being hit by a global downturn, had been blamed by economists on fiscal dominance of monetary policy before 2007.

Sri Lanka created money printing central bank in 1950, and central bank credit (printed money) has been used to finance unsustainable deficits since then, causing high inflation and rupee depreciation and general impoverishment of the population.

Treasury pressure to print money for deficit finance and keep down interest rates is known as ‘fiscal dominance’ of monetary policy.

Sri Lanka’s interest rates have been chronically high due to excessive government spending and the need to combat high inflation triggered by fiscal dominance. Sri Lanka’s current woes started with the deficit spending policies in 2004.

However the Central Bank has now brought 12-month inflation down to 1.4 percent in October allowing interest rates to fall.

Siyambalapitiya said profits of state banks may fall due to pressure to cut rates, but they will not collapse as charged by Sri Lanka’s opposition.

Sri Lanka’s private sector credit expansion had been negative since the beginning of the year.

Analysts say low inflation and collapsing commodity prices which reduced working capital needs had also contributed to slowing credit needs.