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Economy In Crisis..

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1Economy In Crisis.. Empty Economy In Crisis.. Sun Jun 24, 2012 6:59 pm


Manager - Equity Analytics
Manager - Equity Analytics

Central Bank of Sri Lanka’s (CBSL’s) credit cap of 18%, ie, restricting private sector credit growth this year to 18% year on year (YoY) has been instituted to avoid a balance of payments (BoP) crisis, but at what cost?

Will it be at the cost of economic growth? CBSL predicts that the economy will grow by 7.2% this year, down from the previous forecast of 8% due to these restrictions. IMF has predicted an even lower GDP growth target, a figure of 6¾% (See the lead story in last week’s “Economy” page of this newspaper’s).
Lower growth doesn’t help to make wealthier citizens and neither the creation of newer and better paying jobs in a “low paying economy” like that of Sri Lanka’s.

Growth is expected to slowdown not only due to credit restrictions, but also due to other policy decisions/actions as well, which would negatively impact on growth, such as the raising of policy rates, a knock on effect of which would make credit more expensive, the free float of the rupee, raising import duties on vehicles, increasing the administered prices of petrol, electricity, bread, gas, cement and milkpowder, and last but certainly not the least, the increase in administered bus fares as well, as a result of the increase in diesel prices.

Additionally, a slowdown in exports, made worse by the sovereign debt crises in the euro zone, with Sri Lanka’s single biggest export market being the EU, doesn’t help matters either.

Similarly, those policy actions of the Government of Sri Lanka (GoSL) also do have a retardatory reaction on growth because of its impact right down the chain.

The economy grew by 8.3% last year*, buttressed by a 34.5% YoY credit growth to the private sector. If this is prorated to the reduced 18% rate by linking it to growth, on the presumption that bank credit to the private sector is directly correlated to growth, then the economy will grow not by 7.2% as predicted by CBSL, or the 6¾% predicted by the IMF, but by a lower 4.3% this year, 2.9 percentage points less than the revised growth target of 7.2% as set forth by CBSL or by 2.45 percentage points less than that which has been forecast by the IMF.

In 2010, on the back of a 24.9% YoY credit growth, Sri Lanka’s economy grew by 8%. If the 18% credit growth figure is prorated into this growth figure, then the economy will grow by 5.8% this year, still 1.4 percentage points less than CBSL’s envisaged 7.2% growth target and 0.95 percentage points less than that of the IMF’s growth target for the year.

But then credit growth is only one facilitator of providing a thrust to GDP growth, among some of the others being exports, exchange and interest rates, inflation, and yet another being the weather-just five other such examples among several around which GDP growth rotates. For instance if there are sufficient rains that will boost hydropower, thereby minimizing the requirement to be dependent on the more expensive and growth debilitating imported fossil fuels for power generation.

Similarly, good weather will also help to provide better agriculture harvests, further boosting GDP growth.
However that may be, under CBSL’s new credit ceiling laws, banks may increase lending by a further 5%, provided that access to this type of additional finance is obtained from offshore sources and not from internally generated funds (such as by deposit mobilization from the domestic market).

This is another ploy by CBSL to curb a BoP crisis threatening to overtake the economy, ie by placing a cap on domestic borrowings for the purpose of buying foreign exchange (forex) to make imports, thereby eroding the country’s sparse forex resources.

“But the ‘catch’ in foreign borrowings is that due to the sovereign debt crises in the euro zone, made worse by Sri Lanka’s poor, below investment grade international ratings, borrowings from international markets may entail a high cost of between 7-8%,” a banker attached to one of the top four commercial banks in the country told this reporter.

The volatility of the ER makes matters even worse, because when it comes to paying back such loans, one wonders whether in addition to the high borrowing costs involved, the bank would also suffer an ER loss? he said.

Nevertheless another banker alleged that most of the island’s top banks appeared to have had met more than 50% of the credit target as of date (see also The Sunday Leader business pages of 10.6.12.).
According to him, some of the top four banks in Sri Lanka have even been talking about a deposit rate reduction because of this. In recent times due to a liquidity crisis prevailing in the economy, partly due to high inflationary pressure caused by price hikes and the free float of the rupee, that has tended the ER to weaken due to deficits in the island’s trade and current accounts, a sign that $s available are insufficient to meet demand, thereby exerting pressure on the rupee to depreciate, coupled with high credit and import growth (import growth too ipso facto leads to credit growth), causing most banks, including finance companies to hike rates to meet this situation, ie, as a carrot to entice depositors to park their cash with them so that their liquidity needs would be met to lend to the market.

However another banker, whose bank is among the top four commercial banks in the island said that they were not only facing a liquidity crunch, but there was also pressure on their non performing loans (NPLs) to go up because of the higher borrowing costs involved, a consequence of which is because of the higher deposit rates offered as an inducement to the public to park their money with banks, which, ipso facto also leads to higher lending rates being charged to borrowers.**

If banks can’t lend, which is their core business, then they might as well pack their bags and go home.
So deposit rates at any cost and lending rates at any cost, albeit at higher rates, appear to be the name of the game, to ensure that the banking business goes on, despite a liquidity crunch in the economy!
Policymakers may be aware of this situation, but the question is whether from a political and from an economic perspective they are also prepared to take the necessary steps to right the situation? (See also the lead story on the business page).

*According to GoSL, the economy grew by 7.9% in the first quarter of this year.

**According to Dr. John Nelmes, IMF’s team leader for Sri Lanka, though there is stress for banks’ NPLs to go up, the banks here were well capitalized and liquid (see also this newspaper’s last week’s “Economy” page).

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