The unusual monetary policy transition lag - the time taken for the monetary policy action to reflect in market interest rates and inflation is puzzling Central Bank (CB) officials, as even after 20-months in to the monetary easing, the projected private credit is yet to materialize.
According to CB Deputy Governor Dr. Nandalal Weerasinghe, monetary policy transition usually takes between 6 to 18 months in every country, but in Sri Lanka it hasn’t happened so far. though the CB has been maintaining an accommodative monetary policy stance since
“This is a problem we are facing,” he said speaking at a seminar titled ‘Sri Lanka’s monetary policy program’ organized by the Ceylon Chamber of Commerce.
Starting from December 2012 through January 2014, CB’s key policy rates - the Standing Deposit Facility Rate (Repurchase rate) and the Standing Lending Facility Rate (Reverse Repurchase rate) were reduced by 125 and 175 basis points respectively, to historical lows of 6.5 percent and 8.0 percent.
However in July 2014, Sri Lanka’s private sector credit growth on a Year-on-Year (YoY) basis slowed to more than 4 ½ year low of 0.8 percent before picking up to 2.8 percent YoY in August. During the 1H’14, private credit growth was just above 2.0 percent. The full year target is set at 16 percent.
According to Dr. Weerasinghe, even though “immediately short term interest rates responded very fast,” long term rates such as Average Weighted Prime Lending Rate (AWPR ) and Average Weighted Lending Rate (AWLR) have not adjusted according to the key policy rates.
The short term Average Weighted Call Money rate (AWCMR) declined to 6.24 percent by October 2014, CB
AWPR is the rate charged by the banks for their prime customers and AWLR is the overall lending rate in the economy. However, AWPR has showed
some flexibility, but AWLR has been somewhat rigid.
Dr. Weerasinghe re-iterated the fact that the extremely low private credit was mainly due to the contraction of gold –backed loan portfolio from Rs.650 billion early last year to around Rs.350 billion by now.
However he said there had been at least around 12 percent private credit growth so far during the year, barring the pawning anomaly which is led by industry and services sectors.
Industry and services sector credit has grown by 14.2 percent and 12.0 percent respectively during the year ended June 2014, while credit extended to the agricultural and fishing sector dipped 15.7 percent as such loans were taken under gold-backed loans.
Besides, the draught which prevailed during the first 1H’14 also caused agriculture sector loans to contract, Dr. Weerasinghe added.
During the year ended June 30, 2014, pawning loans contracted by 40 percent (Rs.134 billion). However, the credit card balance increased by 14.6 percent
Credit and GDP growth Paradox
Responding to the ‘creditless growth’ criticism by some quarters, Dr. Weerasinghe said there was a shift in financing the current high levels of economic growth from private credit to off-shore financing, but said economic growth without credit growth is not sustainable.
“Growth (economic) remains almost steady though private credit was low. So, that is basically a dilemma for some people.Which means the monetary policy expansion has happened not necessarily through private sector credit but other ways, specially from the external sector in terms of external borrowings by the government and the private sector, pick up in export earnings and strong remittance flows,” he explained. When the CB issues Rupees for these dollar inflows, it creates additional monetary expansion which in turn supports the economic growth.
Therefore, according to Dr. Weerasinghe, the current level of economic growth has not been financed by private credit but by strong external flows.
“But that can’t happen continuously and that’s why we thought we need to come back to the normal situation where growth is financed by both domestic and external sources,”
In September, CB limited commercial banks to park excess liquidity at SDF of 6.5 percent to thrice a month and in exceeding three times at 5.0 percent in order to discourage the banks to approach CB and lend those excess money to productive economic sectors.
At the end of 1H’14, there was close to Rs.400 billion worth of banking sector excess liquidity.
Sri Lanka’s economy grew by 7.7 percent during the 1H’14.
The CB wants to maintain the short term interest rates at 6.0 percent with a mid-term inflation target of 3-5 percent.