Central Bank removes maximum interest rates on forex deposits

The Central Bank issued fresh directions to licensed commercial banks and the National Savings Bank (NSB) last week rescinding the earlier instructions issued on capping the interest rates offered on foreign currency deposits, effective from March 11. 

The fresh instructions came after the Central Bank a fortnight ago decided to raise rupee interest rates by 100 basis points and allowed greater exchange rate flexibility days later. 

Accordingly, the Central Bank sent fresh directions to banks to shed hitherto existed 5 percent cap on foreign currency deposits. 

Earlier directions said banks must pay the higher between the 1-year Treasury bill rate, less 150 basis points or 5 percent for deposits with 1-year or less maturity. 

“Considering the recent monetary policy tightening measures, the expected macro-economic developments and the prevailing interest rates on foreign currency deposits of licensed banks, the Monetary Board hereby issues an amendment to the Monetary Law Act Order No.03 of 2021 on maximum interest rates on foreign currency deposits of licensed commercial banks and the National Savings Bank, removing the existing maximum interest rate limits imposed on foreign currency deposits of licensed commercial banks and the National Savings Bank,” the Central Bank said.

The maximum rates imposed earlier on foreign currency deposits were aimed at discouraging foreign income earners holding their earnings in foreign currency at higher rates offered for them without converting them into Sri Lankan rupees.This created the dollar liquidity crunch in the domestic market as the exporters and others resorted to borrow cheap in the rupee market, making the most of the ultra-low interest rates that prevailed and avoided to convert their earnings into rupees, both due to the arbitrage opportunity available for them and the increased uncertainty in the domestic foreign exchange market. 

As a result, the Central Bank resorted for tougher rules on exporters and other service income earners in foreign currency by slapping them with mandatory conversion requirements. 

However, the rules spooked the market participants and thus the Central Bank finally had to let go the rupee to find its own value in the market from last week, which will provide more flexibility and predictability for the markets to operate with confidence.