The Central Bank of Sri Lanka (CBSL) has announced a significant shift in its monetary policy, signaling a fresh round of easing with the introduction of the Overnight Policy Rate (OPR). This move marks a historic change in how CBSL implements its monetary policy, with the aim of enhancing the efficiency of policy rate transmission to market rates while supporting economic recovery.
Key Highlights of the Policy Change
- Introduction of OPR:
At its meeting on 26 November 2024, the Monetary Board of CBSL decided to set the newly introduced OPR at 8.00%, marking a policy rate reduction of approximately 50 basis points from the existing Average Weighted Call Money Rate (AWCMR). - Simplified Rate Mechanism:
CBSL transitioned from a dual policy interest rate mechanism to a single rate system. The OPR now serves as the primary tool for signaling and operationalizing monetary policy, while the Standing Deposit Facility Rate (SDFR) and Standing Lending Facility Rate (SLFR) are linked to the OPR with a margin of ±50 basis points. As of now:
- SDFR stands at 7.50%
- SLFR is set at 8.50%
- Focus on Inflation Targeting:
The new system aligns with global best practices for inflation targeting. CBSL aims to guide inflation toward the target of 5% over the medium term while fostering economic activity. - Not Linked to IMF Program:
CBSL Governor Dr. Nandalal Weerasinghe emphasized that this initiative is not a requirement of the International Monetary Fund (IMF) but part of CBSL’s independent monetary strategy.
Rationale Behind the Policy Shift
The decision to ease the monetary policy comes after a thorough analysis of domestic and global economic conditions. CBSL highlighted several factors driving this change:
- Deflationary Environment:
Recent data shows that headline inflation, measured by the Colombo Consumer Price Index (CCPI), turned negative in September 2024 and remained so in October. Core inflation has also moderated, reflecting subdued demand pressures in the economy. - Favorable External Conditions:
Improved earnings from tourism and remittances have bolstered the external sector, while the Sri Lankan rupee appreciated by 11.0% against the US dollar in 2024. Gross Official Reserves (GOR) reached $6.5 billion by the end of October, further supporting economic stability. - Moderated Market Rates:
Lending rates have declined significantly in response to CBSL’s accommodative stance, leading to an expansion in private sector credit and reduced pressure on government securities yields.
Economic Implications of the OPR
- Supporting Economic Activity:
By lowering policy rates, CBSL aims to stimulate domestic demand and boost economic activity. Credit growth in the private sector, already showing broad-based expansion across major industries, is expected to accelerate further. - Navigating Inflation Trends:
While headline inflation is projected to remain negative in the short term due to reductions in fuel prices and transport costs, it is expected to turn positive by mid-2025. CBSL’s policy adjustments will help guide inflation toward its 5% target over the medium term. - Strengthening the External Sector:
Improved foreign exchange inflows, supported by the continuation of the IMF Extended Fund Facility (IMF-EFF) and multilateral assistance, are expected to enhance external sector resilience and investor confidence.
Market Response and Future Outlook
The introduction of the OPR has already influenced market behavior, with Treasury bill rates adjusting to reflect the 50 basis point reduction. CBSL anticipates that its measures will create a stable financial environment conducive to growth.
CBSL is committed to a data-driven approach, closely monitoring macroeconomic indicators to ensure that the inflation target and economic growth goals are achieved. The Monetary Board will continue to review conditions and make adjustments as necessary to maintain stability.
Conclusion
The CBSL’s historic move to introduce the Overnight Policy Rate represents a decisive step in its monetary policy strategy. By simplifying the rate mechanism and focusing on efficient rate transmission, CBSL aims to support economic recovery, stabilize inflation, and enhance financial market operations. This policy shift reflects CBSL’s proactive approach to addressing current challenges while paving the way for sustainable economic growth in Sri Lanka.
For more details, visit the CBSL website.
