• Keeps policy interest rates unchanged as previous actions still have room to take root 
• CB slashed policy rates by 250bps in 2020 on five occasions 
• MSME lending targets aimed at supporting economic revival

While deciding to keep policy rates unchanged at the maiden policy meeting held for this year on Monday, the Monetary Board of the Central Bank yesterday announced the introduction of lending targets for small business to accelerate the money flow into the productive economy.

“…in support of the envisaged economic revival, the Monetary Board underscored the need to promote the MSME sector, which is the mainstay of the economy. Thus, the Board decided to introduce priority sector lending targets for the MSME sector in consultation with the banking community,” the Monetary Policy Review released by the Central Bank stated.  

The specific targets are expected to be announced in due course after the consultation process with the banking community is concluded.

The Central Bank relaxed its monetary policy stance to unprecedented levels in 2020 with a view to reviving the economy affected by the pandemic. In response, both market deposits and lending rates declined notably in 2020. Most market interest rates have declined to single digit levels, while some have reached their historic lows. 

Although deposit rates are not expected to decline further, the Monetary Board is of the view that high level of excess liquidity in the domestic money market leaves sufficient space for market lending rates to adjust downwards, thereby providing low cost funds to the economy.

Further, the Central Bank expects inflation to remain at benign levels in the near term, which provides wiggle room for the Monetary Board to remain dovish in the foreseeable future. 

The quarterly headline inflation projections, which the Central Bank said they would begin publishing from this year, showed that inflation is unlikely to return before 2Q of 2022, and that too around 5 percent, within the 4 to 6 percent desired range. 

Sri Lanka’s December headline rose to 4.2 percent while the core inflation accelerated to 3.5 percent over the same months in 2019. 

Inflation is a key anchor in determining the monetary policy under the inflation-targeting framework the Central Bank has adopted and the Monetary Board rules out the possible return of demand-driven inflation due to current depressed conditions.

However, if any supply shock, in the domestic market or international market could push the prices up, though less threateningly. 

Meanwhile, the recent developments of the economy prompted the Central Bank to upgrade the gross production projection for 2021 from around 5 percent to 5-6 percent as private sector credit growth has continued its momentum and the domestic production happens at a faster pace than expected, energizing export trade. 

 
The Purchasing Managers’ Index data for December showed acceleration in both manufacturing and services sector activities, with expectations for near term continuing to remain positive. 

The Central Bank on Monday left the Standing Deposit Facility Rate (SDFR) or the rate at which the excess bank liquidity is mopped up, at 4.50 percent, while the Standing Lending Facility Rate (SLFR) at 5.50 percent, after slashing both rates by 250 basis points in total five times in 2020. 

The banks’ mandatory reserves ratio was left unchanged at 2.0 percent. 

The record levels of excess liquidity in the money market also may have nudged the Monetary Board to remain pat as that should induce the rates to decline further.