By Chandeepa Wettasinghe
A regulatory credit crunch may likely be implemented for the construction and real estate sectors to protect the financial system, the Sri Lankan government had said in a letter to the International Monetary Fund (IMF).
“To strengthen our financial system, we intend to undertake several measures: Deploy, as needed, macro-prudential tools such as a sector-specific limit on the loan-to-value ratio including in the construction and real estate sectors,” the letter said.
Signed by Finance and Mass Media Minister Mangala Samaraweera and the Central Bank Governor Dr. Indrajit Coomaraswamy, the letter indicates the continuously rising concerns of the regulators over the possibility of an asset bubble.
The letter was written in June and published in the report for the Second Review of the IMF’s US$ 1.5 billion Extended Fund Facility, but Dr. Coomaraswamy had issued cautious statements over a possible asset bubble stemming from luxury apartments over the preceding months.
He had also said that private credit has to be observed to discern whether loans taken for other purposes are leaking into real estate.
It was recently revealed that his comments had followed dwindling pre-sales of apartments, possibly driven by reduced economic expectations and tighter monetary policy, instead of the comments causing the decline as believed by real estate firms.
Lower pre-sales may cause property developers and in turn construction firms to depend on alternative finances to complete projects. However, developers insist that they have not started projects for which a majority of costs have been covered through pre-sales.
Fortune 500 real estate consultant firm JLL has forecasted that the supply of property development will eventually be absorbed by the market.
Many artificial elements are pushing up real estate prices in Colombo, as reported by Mirror Business last week.
Construction is one of the major drivers of growth in Sri Lanka, and makes up around 8 percent of Gross Domestic Product (GDP).
This is still much lower than economies of similar sizes.
However, unlike such other economies, Sri Lanka performs poorly in tradable goods and services, which should ideally lead to higher demand in improved real estate.