Central Bank imposes 5% maximum rate on forex deposits in local banks

• 5% cap was already in place but banks were offering negotiated rates to their big customers
• However, new directive will make such negotiated rates unviable and rate will be capped at 5%
• But 5% cap will not be applicable to special foreign currency deposits introduced last year

Reinforcing an early cap imposed on the foreign currency-denominated deposits by the local banks, the Central Bank yesterday issued an order stipulating the maximum rate at 5.0 percent for deposits denominated in foreign currency up to one year, barring for special foreign currency deposits the regulator introduced last year. 

Central Bank Governor Professor W.D. Lakshman last week said they mull a ceiling on foreign currency deposits held by exporters in a bid to address any anomaly existed between the interest rates on foreign currency deposits versus rupee deposits and thereby either minimise or remove any advantage they have on holding dollar deposits, making them to convert into rupees. 

“The maximum interest rates that may be offered or paid by a licensed commercial bank and National Savings Bank on all foreign currency (FCY) deposits shall not exceed an Annual Effective Rate (AER) of up to 5 percent,” Monetary Law Act Order No.02 of 2021 read. 

However, the special foreign currency deposit accounts, which were introduced at the onset of the pandemic last year to attract dollar inflows, will continue to offer 2.0 percent additional interest rate over and above this rate.  

Mirror Business earlier this week brought to notice that the 5.0 percent cap had already been effective for sometime on foreign currency deposits (FCYDs) and what the Central Bank meant last week was a lower cap targeting FCYDs held by the exporters to dis-incentivise them from holding on to them any longer. 

Despite the 5.0 percent ceiling rate, there could have been instances where banks offer slightly higher rates for their closest and big customers based on their relationship and also to woe them into placing such FCYD in their banks to build dollar foreign currency liquidity.  

However, these offers almost always happen close doors and never come out into the market. Nevertheless, with the requirement of mandatory submission of weekly returns containing rates of interest on FCYDs by banks to the Central Bank, possibility for negotiated rates over and above the cap rate could become unviable.  Yields of dollar assets became attractive, due to the higher risk premium attached to them, after the global rating agencies downgraded Sri Lanka’s sovereign credit rating last year. 

For instance, the secondary market yields of international sovereign bonds issued by Sri Lanka hover over 20 percent or at deep discounts, as bond yields and prices are inversely related. Sri Lanka Development Bonds at the most recent auctions held between August 6 and 11 were issued at the 7.82 percent rate in respect of the nearest maturity of nine months. 

 But the assets of rupee yields fell sharply in response to the fast descent in the domestic interest rates last year. 
However, with last week’s 50 basis point hike in policy rates, there could be upward pressure on the rupee rates, which could minimise any advantage in holding dollar assets and thereby prompting part of that money to be converted into rupees. 

As this practice could improve dollar supply in the market, this could alleviate the pressure on the rupee to a certain degree.