SL should brace for higher interest rates as domestic borrowings set to peak

Despite the government securities yields pointing to a lowering trend, Sri Lanka is most likely to face higher interest rates during most part of 2018 as the Central Bank will have to borrow excessively from the banking sector to settle domestic borrowings. 

Borrowings from domestic banking sector put pressure on interest rates and also leave little resources for private sector borrowings – a phenomenon often referred to as the ‘crowding out effect of the private sector’ by economists.

On an earlier occasion, the Central Bank said that Sri Lanka’s domestic debt repayment challenge in 2018 is going to be much worse than that of this year’s as it reaches a peak in domestic debt repayments after which there is a bunching up of foreign debt repayments, mostly the international sovereign bond (ISB). 

“On the debt dynamics, this year and next year, there is a peak in domestic debt repayments. Then, there is a bunching up of external debt repayments from 2019 onwards,” Central Bank Governor Dr. Indrajit Coomaraswamy said.

While the situation may be under control with the improved fiscal situation, the debt condition could further exacerbate if the government deviates from its fiscal consolidation path and records a higher deficit in the budget at the risk of irking the International Monetary Fund (IMF). 

But it is expected that the new Inland Revenue Bill would enhance the government revenues substantially as the new bill, which was prepared in direct consultation with the IMF, has almost zero tax exemptions and holidays. 

In a positive development, the Central Bank with a more proactive approach is seen building buffers of late to face what could be termed as the ‘worst of period’ in terms of domestic debt. 

“Next year’s challenge is actually even bigger than this year’s. So, it’s important that we build these buffers during the last five months of this year, so that we can manage that without too much of a spike in the interest rates,” Dr. Coomaraswamy told reporters in Colombo, recently.

Sri Lanka’s government securities yields have been on the decline since end-April this year due to less borrowing pressure resulted by better checks and balances on government budget.