Despite inflation picking up at the later stages of 2009 and short term market interest rates picking up over the past few weeks, the Central Bank said policy rates would remain unchanged for the time being as inflationary pressures are expected to remain subdued during the course of the year.

The Monetary Board of the Central Bank meeting on Monday decided to maintain the repurchase rate (the rate applicable for overnight commercial bank deposits with the Central Bank) at 7.50 percent and reverse repurchase rate (the rate applicable for commercial bank overnight borrowings from the Central Bank) at 9.75 percent.

A year ago, the repurchase rate and reverse repurchase rate were 10.50 percent and 12 percent respectively. Inflation which peaked at 28.2 percent in June 2008 gradually declined since then reaching 0.7 percent in September 2009 allowing the Central Bank to cut policy rates in a bid to stimulate private sector credit growth.

But since September 2009, inflation has picked up again, reaching 4.8 percent in December.

"The gradual increase in inflation, on a year-on-year basis, was expected, given the low base and the rebounding of international commodity prices along with the recovery in the global economy. Nevertheless, projections of inflation for 2010 indicate benign inflationary pressures, enabling inflation to be in single digits by year end," the Central Bank said yesterday in its Monetary Policy Review for January.

Despite low inflation and policy rates, short term money market rates have been increasing marginally over the past few weeks.

Benchmark Treasury bill rates which had been at 7.25 percent for three months, 8.33 for six months and 9.17 percent for twelve months last November increased marginally each week to 7.84 percent, 8.82 percent and 9.38 percent respectively last week.

"Though some volatility has been observed in the short term money market rates in recent weeks, market interest rates have declined to lower levels by end 2009 in response to the monetary policy measures taken by bank," the Central Bank said.

"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. It is expected that this development would be further strengthened along with activity in the domestic economy picking up in the period ahead," it said.

As reported yesterday, credit to the private sector recorded a positive month-on-month growth since September 2009, reaching 1.02 percent in November 2009.

Although year-on-year growth in November was still negative, the Central Bank says it would record positive growth during the second quarter.

As at November 2009, credit to the private sector was Rs. 1.188 trillion, up from Rs. 1.176 trillion during the month before, a positive but marginal 1.02 percent growth, economic data released last Friday by the Central Bank showed.

However, year-on-year, private sector credit growth was still a negative 5.8 percent for November 2009 with growth for November 2008 a positive 7.6 percent.

Dealers told the Island Financial Review that they expected policy rates to remain steady for sometime despite concerns that inflation could pick up gradually during the year as the global financial crisis shows signs of recovery.

The direction of public finances is another area of concern among dealers. "But if the government can stick to IMF targets, which is challenging, then inflationary pressure caused by deficit financing can be curtailed," a dealer said.

Despite low market interest rates compared to last year —the average weighted fixed deposit rate at 10.91 percent as against 16.89 percent in January 2009 and the average weighted prime lending rate 11.03 percent down from 18.60 percent in January 2009 — uncertainty prevails in the market due to upcoming elections and dealers said borrowings have almost dried up.

The dollar traded at around Rs. 114.20/25 yesterday while the rupee surplus held on Monday was around Rs. 19 billion, dealers said.