Central Bank to place ceiling on rates of dollar deposits held by exporters

The Central Bank intends placing a ceiling on rates of dollar deposits held by exporters in a bid to narrow the gap between the rates offered between the deposits denominated in rupees and dollars, and rupee loans.

The exporters have tended to keep receipts in dollar deposits without converting them into rupees as the dollar deposits earn a higher interest rate after the rating downgrades of the Sri Lankan sovereign pushed dollar yields high due to the higher risk premium attached on Sri Lankan sovereign bonds and other bonds denominated in United States dollars.

However the exporters and other actors of the economy attracted by the lowest lending rates, borrowed in rupees to fund their operations adding further pressure on the rupee as part of such money ends up flowing out as imports.

The dollar deposit rate cap is expected to resolve this issue to a certain degree as their incentive to keep their earnings in dollars will reduce while encouraging them to convert their earnings into rupees.

“ Our intention is to impose these restrictions or the caps on deposit rates on export earnings that are kept in foreign currency accounts because there is a discernible difference between the rates that are paid on those deposits and also rates that have to be paid on rupee loans,” said Central Bank Governor, Professor W.D. Lakshman.

“In order to sort out the problems created by this, this is one of the measures that is proposed”, he added.

However the banks are already prevented from offering over 5.0 percent per annum for dollar deposits and hence it is not yet clear if the Central Bank is referring to a ceiling rate below 5.0 percent targeting exporter dollar deposits.

The Monetary Board last week raised its key rates by 50 basis points partly to resolve this anomaly in the interest rates between the dollar and rupee liabilities and assets and the exchange rate between the US dollar and the rupee.

For instance, when market interest rates start inching up in response to the key policy rate hike last week, the gap between the dollar deposits and rupee deposits could narrow, reducing exporters of the advantage they have on keeping their earnings in dollar deposits. This could nudge them to convert them into rupees.

A lower cap on dollar deposits could take away any remaining incentive for them to keep their dollars in such deposits.

On the other hand, the rising lending rates in the domestic market would increase the rupee cost of importers in funding the imports and thereby lessen the incentives they currently have on importing.

The duel impact would reduce the pressure on the rupee/dollar exchange rate and thereby would reduce the gap in the official and unofficial exchange rates in the market for dollars. However, the classical economists believe that if the rates are allowed to be determined based on market forces without liquidity injections to keep domestic interest rates down, interventions such as placing caps on dollar deposits arent required as imports would adjust downwards as higher interest rates would tamp down the desire for domestic consumption and investments, the two factors which trigger demand for imports.

However, the pandemic necessitated the Central Bank to carry the bulk of the weight in supporting the people and the enterprises beset by the pandemic by way of cash transfers, liquidity support and lowering the cost of money when the fiscal space to provide such support in Sri Lanka remains limited. Further, the interest rate and the tax policy are integral tools in stimulating the priority segments in the domestic economy without which building new industries and assisting existing industries in reaching the next level is difficult to happen.