ECONOMYNEXT - Sri Lanka is studying trends in property lending and loans to small and medium industries to pre-empt any property bubble bursting, Central Bank Governor Indrajit Coomaraswamy said.
In the recent past, property prices have moved up sharply. Coomaraswamy said property returns were among the best seen in the country in any investment avenue, and it was natural for money to flow. But when too much money flows, tears follow, he told members of Sri Lanka's Foreign Correspondents Association.
Sri Lanka has also seen an apartment boom, with fears that it may burst.
A central bank typically generates a property bubble by resisting rises in interest rates for too long which makes the present value of long-term assets go up, giving rise to a so-called asset-price bubble.
Because a central bank resists interest increases by holding policy rates down, property bubbles grow higher and for a more prolonged period before rates are eventually raised to correct them, compared to a non-central banking regime, experience in the US has shown.
The most recent example was the collapse of the property and credit bubble in the US in 2009, sending shockwaves worldwide, which was followed by prolonged low interest rates from 2001.
Usually, in pegged exchange rate regimes, BOP troubles develop quicker when rates are kept low for too long by a central bank, and it may prevent bigger domestic asset-price bubbles from developing, compared to floating rate regimes.
Sri Lanka's last property bubble collapsed also around 2008 with the downfall of the Ceylinco Group property companies and some other finance companies, which kept property prices stable for a long period.
Analysts say a central bank can also extend the imbalances by trying to limit credit through administrative moves to particular sectors instead of allowing credit markets to work through price signals.
This is common in developing countries, and was practised in developed markets earlier with similar results.
Sri Lanka had already squeezed credit to three-wheelers and other vehicles in a typical knee-jerk administrative response, which will force lenders to pour more money into other sectors such as property, critics warn.
Coomaraswamy said loans to the construction sector were strong. Some SME lending, which was also strong, could be going into property, although it was not classified as such.
He said some business owners seem to be pulling money out to buy property, leveraging their businesses.
The monetary board of the central bank will decide on measures, if any, after the study on property credit is out, he said.
Sri Lanka's lending interest rates are now higher and government fiscal deficit is falling. (Colombo/May20/2017)