August 7, 2014 / 6:41 AM / 3 years ago

UPDATE 1-Sri Lanka c.bank: Greater chance of rate cut than hike

4 Min Read

* IMF has urged c.bank to hold policy rates, limit intervention

* Yields under downward pressure on c.bank's heavy dlr buying

* C.bank chief: can achieve 2014 credit, BOP surplus goals (Adds quotes, background)

By Shihar Aneez

Aug 7 (Reuters) - Sri Lanka's central bank chief said on Thursday there is a greater chance of a cut in key monetary policy rates than a hike, despite the IMF's advice to keep key rates on hold for the near term.

The central bank chief's comment came a day after yields on one-year government debt fell to 6.45 percent, below the rate of 6.50 percent at which the central bank mops up liquidity from commercial banks.

The central bank has been maintaining the key policy rates at a multi-year low since January to spur economic growth.

"The chances of rate reduction are more than chances of rate increase," Central Bank Governor Ajith Nivard Cabraal told Reuters in a telephone interview.

The International Monetary Fund, which has lent $2.6 billion to Sri Lanka, last week urged the central bank to keep key interest rates on hold for the near term, saying a "cautious approach is warranted".

Despite the policy-easing measures, growth of credit extended to the private sector has slowed to 2.2 percent year-on-year in May, its lowest since January 2010 and falling from 3.3 percent in April, the latest data showed.

"We are satisfied with the credit conditions," Cabraal said referring to the credit data after May.

"We see some new sectors coming in and those avenues are now using the credit. The credit growth will pick up and reach to the level we have envisaged early this year."

The central bank has estimated the $67 billion economy to expand at 7.8 percent this year, from a 7.3 percent in 2013. It also expects private sector credit to expand by 14 percent by the end of this year compared to 7.5 percent at the end of 2013.

Stable Rupee

The central bank's intervention in the foreign exchange market to keep the rupee stable has pumped more than $1 billion in local currency into the banking system.

The IMF last week said the central bank's intervention may create a perception that the rupee's exchange rate is implicitly fixed and it could lead market participants and firms to hold un-hedged foreign exchange risk on their balance sheets.

The rupee traded at 130.18/20 at 0601 GMT on Thursday. The central bank last month said that, had it not absorbed the dollars from the market, the currency would have appreciated to 125 rupees per dollar.

Banks say the increased liquidity has compelled them to invest all their spare cash in low-risk government securities.

"Of course liquidity will be high whenever there is a lot of inflows, which are from exports, various projects, portfolio investments and remittances," Cabraal said. "With these inflows we can achieve the $1.5 billion balance of payments surplus target as expected."

The economy grew by 7.6 percent in the March quarter, which analysts attributed to strong government spending on massive infrastructure projects financed with external commercial funds.

Despite low policy rates, demand for imports has contracted - resulting in the trade deficit shrinking for the eighth consecutive month in May. (Reporting by Shihar Aneez in New Delhi; Editing by Douglas Busvine and Simon Cameron-Moore)

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