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Sri Lanka will hike rates if there is more global instability: CB Governor

Feb 26, 2016 07:04 AM GMT+0530 | 4 Comment(s)

RATE VIEW:  Sri Lanka to raise rates if here is more instability

ECONOMYNEXT - Sri Lanka may have raise interest rate if there is more global instability leading to foreign outflows, though a recent rate hike was 'unfortunate', Central Bank Governor Arjuna Mahendran said.

"We had to resort to the unfortunate interest rate hike last week on the basis that growth of bank lending is running at 25 percent," Central Bank Governor Arjuna Mahendran told reporters.

"It's a good thing that banks are willing to lend. But if we end up with a massive credit bubble, it will create more problems than it solves."

He said under the central bank's governing law, it was obliged to send a report to the finance minister if credit growth exceeds 15 percent.

But credit growth topped 26 percent in November and December.

Foreign bond holders were also selling out of the market creating pressure on the rupee.

If global instability continues, Sri Lanka may have to raise rates again, he said.

Bond holders were selling because they feared more losses with the rupee depreciating and the US dollar strengthening.

"We have to preserve our currency from going into a fee fall," Mahendran said.

"Raising interest rates will ensure that the currency stabilizes and settles down."

Sri Lanka has a de facto peg with the US dollar and runs into currency trouble every time the credit cycle turns, because the central bank delays rate hikes by printing money, either the finance deficits or because it is growth happy, critics have said.

Mahendran said policy rates were now back at levels seen in April when 50 basis point rate cut was made.

In April the central bank cut policy rates, despite rising domestic private and state credit and analysts were expecting balance of payments trouble.

However active defence of the peg, mops up liquidity that is generate and pushes interest rates upward, helping regain some economic stability.

Banks on their own raised deposit rates about 200 basis points since October 2015. Raising deposit rates allows banks to generate more deposits and extend more credit for investments by curbing consumption. (Colombo/Feb26/2016)
 


 

4 Comments

  1. DS March 01, 08:15 AM

    His capabilities are now well exposed. It is obvious that this another attempt to take cover behind global uncertainties. In private sector a CEO cannot go on giving excuses for non performance. Either you deliver or out you go

  2. Mr D February 27, 12:32 PM

    My dear EN brethren, this is the 2nd and final part of my comment. So please do read the comment below before this one. Lets resume.Mr Mahendran, you said SL will raise rates if there is more global instability. You make it seem like as if raising rates is something we shouldn't be doing in this period and also that there possibily isn't global instability and its just a rumour. Well, lets take a quick world tour shall we?We begin the world tour with the USA. The USA increased its policy rates by 25BP last December and wanted to originally increase it 3 more times over the course of this year. However, due to China's slowdown and emerging market problems, they decided to rethink their position and are most likely to increase rates cautiously from here. Hence, why their March meeting is important for us to decipher their revised stance. It seems the US acknowledges global instability Mr Governor.Moving onto Brazil and South Africa, both countries are finding it extremely difficult to borrow despite high interest rates offered. The reason is because of fiscal mismanagement. This led them to having to make tough choices in their budgets the past few weeks. Finance Minister Gordhan had his work cut out for him and had to stick South Africa with tough austerity measures in his budget a few days ago, and currently global sentiment isn't on their side post budget.Moving onto the EU, the Brexit debate rages on with the UK contemplating leaving the EU due to differences in opinions regarding immigration laws, amongst other things. The EU situation is pretty unstable, especially when you also consider Dr Draghi's monetary stance.Now would be a good time to bring Japan into the mix. Both the European CB and Japanese CB are currently employing negative interest rates in order to stimulate demand by forcing consumption and investment. However, due to the EU's political situation, its not having the desired effect. In Japan's case, the predicted effect isn't occurring due to the safe haven nature of the Yen being stronger than policy rate strength. The yen has been appreciating when it should have been depreciating as more foreign investors are investing in the yen. This is causing problems for Mr Kuroda, the BOJ Governor and PM Abe, especially with elections coming up soon.With regards to the OPEC countries, they have come to an agreement to freeze supply at January levels, causing the Brent barrel prices to go to USD 34 35 this past week. However, Iran's return to the fold after their sanctions ended, has caused issues due to them being adamant on increasing supply, which would put downward pressure again on oil prices. Hence, theres alot of instability there as well. We'll skip China for now because we all know the dilemma they are facing right now. Just to put things in perspective though, although they are losing close to a 100 billion dollars a month in reserves due to capital outflows, they do have over 3 trillion USD in reserves, so they should make a recovery in due time.Now onto our South Asian brothers. Pakistan is 50 billion dollars in debt and are unable to repay it, so are facing either a default or a bailout. Think of our situation, but slightly more serious. Then theres India. We as citizens of SL should be following the post budget reactions within India, as it may have consequences on the passing of the ECTA. Finance Minister Jaitley is set to present the budget on Monday. Pre budget reactions haven't been good, with foreign selling and riots occurring. Fiscal overexuberance on Modi's part the past few years has caused them to commit to changing their fiscal deficit from 7 to 3.5 per cent but their lack of tax take and cutting back spending is taking its toll on the unemployed graduates. On top of that Dr Rajan, the CB governor of India is screaming at banks to restructure after a poor period of management and loan issurances, so that he can effectively implement monetary policy.So Mr Mahendran, does that look like there may not be global instability right now? The only course of action you have is to increase rates by a much higher degree if you want us to stabilize. I apologise for the brutality of this comment but I felt that it had to be done.Thank you, the EN community for reading this 2 part comment and I hope you found it useful.

  3. Mr D February 26, 06:17 AM

    Alright, enough of this lunacy. Before we get to the title of this article, lets do a small walkthrough of Mr Governor's latest stand up comedy routine. Who exactly are you trying to fool, Mr Mahendran?

    If a credit bubble occurs, it is only because you overextended your welcome with regards to adequate monetary policy. You chose a loose stance in adverse market conditions, defying all logic and rationale. Our export market was not getting the impetus it so desperately needed for small to no fault of its own, just a series of unfortunate world conditions, something that traditional policy rate manipulation could not overcome. On top of that, you felt that it was necessary to accommodate the questionable fiscal stance of your buddy, the finance minister.


    An Oxford educated man such as yourself should know that central bank indepedence from fiscal madness is integral is in its function. So why on earth did you assist this insanity? Why continuously flood the market with liquidity, forcing downward interest rate pressure on the economy, when market forces were going the other way and pressuring for an upward interest rate movement? What right can you then have, to say that a credit bubble could occur when you were the one who provided the tools for it to potentially happen? What reason did you have to lower interest rates this past year? We were walking straight into an overheat, inflation was on the rise and real interest rates were favouring consumption, which was exactly what happened.


    Of course, consumption was import heavy, leading to our trade deficit getting hit. Please do not make the argument that the trade deficit is decreasing. Take the temporary repreive of lower oil prices out of the equation and control for constant import consumption and you get a completely different picture, especially when you factor in the falling worker remittances due to the oil crisis, which we will address in a bit. Please do excuse us if we take a moment to laugh at this sentence. ...obliged to send a report to the finance minister if credit growth exceeds 15.


    It is not like that guy has any idea about what that even means. Clearly, he hasn't responded to this situation although its evidently been an issue for the past 4 months. Back to the story. We've been reliant on capital inflows for quite a while now, especially within the realms of the stock exchange, which is taking a massive hit due to foreign selling. In theory, we get different types of investors who like different levels of risk. However, in practice, the overwhelming majority of foreign investors are risk averse, or people that dont like taking risks, mainly due to the aftermath of the 2007/08 global financial crisis.


    So taking that into account, they need a sufficient reward for investing in risky SL assets. By reducing interest rates, you are telling them that they get less potential returns for a greater risk, especially with the continuing political instability playing a huge role towards the rising risk levels as well as both fiscal and monetary mismanagement, the latter of which you are responsible for, Mr Oxford PPE.


    Its pretty obvious as to why they are running away without looking back. So tell us more about how this interest rate hike is unfortunateDon't worry Mr Governor, I'll help you out. We'll resume with this gem. We have to preserve our currency from going into freefall That was followed by, raising interest rates will ensure the currency stabilizes.. MAKE UP YOUR MIND. YOU CANNOT HAVE IT BOTH WAYS. If a rate hike is unfortunate but you recognise that is necessary to stabilize the currency, then what exactly is unfortunate about it, especially given everything that was discussed above? Did you enter the conference room with a half empty bottle of arrack? That would explain the amateur response you gave.


    Since we are on the topic, why don't we discuss this further. You failed your float attempt, and then continuously failed in your attempts to manage the exchange rate, which forced y'all into calling for desperate measures. You halted the spot market until earlier today, which shows a huge sign of weakness to foreign investors, and traded only on the forward market the past few weeks.


    Even then, you used moral suasion to manipulate the exchange rate, although there was immense depreciative pressure on the currency even on the forwards, which doesn't paint a good picture for us in the global market. Mr Mahendran, why didn't you at least increase policy rates in December alongside the Fed? Maybe then you wouldn't have had to close the spot market and force this issue.


    When you did increase rates, it was so small that it may as well as have been negligible. Did you not study economics along with philosopy and politics at Oxford?Finally, onto the main event. SL will hike rates if there is more global instability. You make it so

  4. sacre blieu February 26, 07:26 AM

    To have printed and pumped money along with the reduction of interest rates and with the black economy outpacing the lawful disciplines, was a recipe for disaster.

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