The International Monetary Fund (IMF) last week expressed its deep concerns over private credit growth which is still running “very strong” despite the multiple rounds of monetary tightening measures and asked the Central Bank to operate with sufficient policy room for further tightening if situation does not turn favourable.
The IMF Mission Chief, Jaewoo Lee said Sri Lanka’s private credit growth is more than double the nominal GDP growth, which is on the high side given the country’s external vulnerabilities.
While Sri Lanka’s nominal gross domestic product (GDP) is around 10 percent, the latest data available up to September shows the credit to the private sector has grown by 25.6 percent. The IMF prefers the private credit growth to remain below 20 percent level which is also what the Central Bank is hopeful of achieving by the end of the year.
“As I mentioned earlier, despite the increasing of policy rates and going back even further in increasing the statutory (reserve) ratio in January this year, which all have contributed to some tightening of liquidity, credit growth has remained very strong and going forward we will keep monitoring the inflation and credit growth,” Lee told the reporters in Colombo from Washington, D.C.
Sri Lanka raised its key policy rates twice this year by 50 basis points each and earlier raised the banks’ statutory reserves ratio by 150 basis points to curtail funds available for loans. But these actions have so far yielded limited results and the authorities relate this to general lag in monetary policy transition.
Sri Lanka has been in the habit of creating cheaper credit to unsustainable high levels over and above the deposits raised by the banks through printed money to keep the interest rates artificially low, which later leads a collapse in the currency through unsustainable higher imports.
It also impoverishes the people by creating higher inflation and also creates asset bubbles.
“We think it is more prudent to avoid another round of vulnerability through high credit growth. So, it would be preferable to be a lot more conservative on credit growth,” Lee reiterated.
Meanwhile, the IMF has also seen signs of sharp rise in housing and land prices. The Central Bank’s land price index for Colombo district has increased by 12.5 percent Year-on-Year in June 2016.
In view of possible bubbles in these sectors, the IMF also suggested the authorities to tighten the monetary stance further and also to impose maximum loan-to-value ratios to curb credit flows into selected sectors.
“If credit growth does not abate as expected or inflationary pressures resurge, the authorities should tighten further the monetary stance. In addition, macro-prudential tools can be applied if needed, including a maximum loan-to-value ratio regulation to curb credit growth,” stated the IMF Staff Report which was presented to the Executive Board’s consideration on November 18.
Nevertheless Lee said that the current monetary policy stance appears appropriate given the moderation in the inflation which is expected to remain around 5.0 percent in 2016 and 2017 and the signs of some deceleration in the private credit growth.
However, the Mission Chief urged authorities to operate with significant policy room for action due to a plethora of uncertainties in the domestic and as well as international fronts.