In a significant move aimed at enhancing the efficiency and transparency of its monetary policy, the Central Bank of Sri Lanka (CBSL) has transitioned to a single policy interest rate mechanism, the Overnight Policy Rate (OPR), effective today. This marks the departure from the dual policy interest rate system previously in place, aligning with the Central Bank’s ongoing commitment to the Flexible Inflation Targeting (FIT) framework.
A Strategic Transition
The transition to the single policy interest rate mechanism was first announced in the CBSL’s Annual Policy Statement in January 2024 and later reaffirmed in September 2024. The introduction of the OPR is positioned as a critical step in modernizing Sri Lanka’s monetary policy framework and strengthening its effectiveness in influencing financial markets and the broader economy.
The CBSL highlighted the significance of this shift, stating: “This transition is expected to enhance the efficiency and effectiveness of monetary policy signalling and transmission to the financial markets and the broader economy.”
Key Features of the New Mechanism
- Overnight Policy
Rate (OPR):
The OPR will now serve as the Central Bank’s primary tool for signalling its monetary policy stance. It will be periodically reviewed and adjusted based on economic conditions to communicate changes in monetary policy effectively. - Targeting the
AWCMR:
The Central Bank will aim to maintain the Average Weighted Call Money Rate (AWCMR)—the rate at which banks transact with each other in the interbank market—at or around the announced OPR, making it the operational target under the FIT framework. - Standing
Facilities:
While the Standing Deposit Facility Rate (SDFR) and Standing Lending Facility Rate (SLFR) will no longer be considered policy interest rates, these facilities will remain operational for overnight transactions, providing the lower and upper bounds for interbank call money rates. - Enhanced
Monetary Policy Communication:
The shift is designed to simplify the policy rate structure, ensuring clearer communication and better alignment between policy rates and market rates.
Impact on the Economy
The transition to a single policy interest rate is expected to improve the predictability of monetary policy and strengthen the Central Bank's ability to maintain inflation at its target rate of 5%. This move aligns with the CBSL’s broader objectives of promoting price stability and fostering economic growth.
A Modernized Framework
The Central Bank’s commitment to the FIT framework underscores its focus on controlling headline inflation while supporting sustainable economic development. The OPR mechanism is anticipated to streamline monetary operations, ensuring that policy signals are effectively transmitted to financial markets and contribute to economic stability.
This policy shift places Sri Lanka among nations that prioritize clear and effective monetary policy frameworks, a critical factor in fostering investor confidence and macroeconomic stability.
The CBSL’s bold step forward reflects its ongoing efforts to adapt to global best practices while addressing the unique challenges of Sri Lanka’s economic landscape.
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