Interest Rate Pass-through in Sri Lanka

Abstract

The Central Bank of Sri Lanka has increasingly been relying on interest rates as the instrument for conducting monetary policy. Changes to the key monetary policy variables, the Repo and the Reverse Repo rates, are initially expected to be reflected in the OMO rates and the call money market rates, before being passedthrough to commercial bank retail interest rates. It is important to obtain a good understanding of the speed and magnitude of the interest rate pass-through to make timely monetary policy decisions in order to meet the objective of economic and price stability. This paper examines the size and speed of the pass-through from policy interest rates to call money market rates and from call money market rates to commercial bank retail interest rates. The paper concludes that the CBSL policy decisions are efficiently transmitted to the short end of the money market within a matter of days. Also, the pass-through from policy interest rates to the call money market rate is almost complete. However, the pass-through from call money market rates to both lending rates and deposit interest rates of commercial banks is sluggish and incomplete. The only exception is, perhaps, the rates on lending to prime customers, which show a faster and a fuller pass-through. Also, there is no evidence of an asymmetry of pass-through over different phases of the interest rate cycle.

Monetary Transmission Mechanism in Sri Lanka: A Comprehensive Assessment with New Evidence

“…For example, existing literature on interest rate pass-through is very limited for Sri Lanka. Amongst the available studies, Amarasekara (2005) examines interest rate pass-through and Aazim and Cooray (2012) examine monetary policy and yield curve dynamics. However, these studies do not focus on the transmission of the impact of interest rates into final policy variables and hence are limited to early stage of monetary transmission.…”

“…Amarasekara (2008) also examines the effects of interest rate, money growth and the movements in nominal exchange rate on real GDP growth and inflation in Sri Lanka, and the results are broadly in line with the established empirical findings, especially when the interest rate is considered the monetary policy variable. Both studies of Amarasekara (2005; provide a comprehensive analysis on monetary transmission in Sri Lanka, but the sample is restricted to 2004. As there are considerable developments in the monetary policy conduct since 2004, it would be imperative to provide new empirical evidence for both interest rate pass-through and monetary transmission within the context of a single study.…”

Interest Rate Pass-Through and Monetary Transmission in Lebanon Loan Market

“…τ 1 or β reflects the degree of interest rate pass-through and its estimated value should be between zero and one. The passthrough is described as sticky if τ 1 is less than one [2]. A value of one denotes a complete pass-through whereas a value exceeds one indicates an overshooting in the passthrough which is attributed to information asymmetries in the market [11].…”

Monetary and fiscal factors in nominal interest rate variations in Sri Lanka under a deregulated regime

“…However, the study fails to produce any evidence supporting the Fisher equation. Amarasekara (2005) studies the interest rate pass-through in Sri Lanka using daily datasets, including the repo, reverse repo, repo auction, and the money rates. The study also examines the size and speed of the pass-through from policy to call money market rates and that from the call money to commercial bank retail interest rates.…”

“…Only few studies (Cooray 2002;Jayasinghe and Udayaseelan 2010;Amarasekara 2005) analyze the behavior of interest rates in Sri Lanka (details are presented in "Brief literature review" section). To the best of my knowledge, the determinants of interest rates in Sri Lanka are not hitherto identified.…”