Bad loans at banks in Sri Lanka surge after 2018 monetary instability

ECONOMYNEXT – Bad loans in Sri Lanka’s listed banks have surged in the first quarter of 2019, as the credit system emerged from monetary instability involving a collapse of the rupee driven by repeated liquidity shocks, published data show.

Monetary instability was worsened by a political crisis in late 2018, which eroded confidence further.

Bad loan ratios of some banks have surged over 150 basis points during the March 2019 quarter, while loan growth was flat or contracting.

In the March 2019 quarter, gross loans at nine publicly traded banks and state-run Bank of Ceylon, which has listed debt, were flat, compared to a 4.5 percent growth in the first quarter of 2018, when the economy was recovering from a previous balance of payments crisis.

Analysts say part of the credit contraction could have come from exporters who unwound rupee borrowing take during the balance of payments crisis.

Under new accounting standards banks also have to recognize bad loans early and most banks have made large provisions to clean up their balance sheets, taking a hit on earnings.

However banks do not have to disclose performing loans separately.

Bad Loans

A rough estimate based on disclosed gross loans show that bad loans may have risen to about 250 billion rupees by end March 2019 from about 138 billion rupees a year earlier and about 50 billion rupees came in the first quarter.

In April Sri Lanka was hit by Islamist suicide bombings, which has hurt tourism, and a debt moratorium had been offered.

About 60 billion rupees of loans may come under the moratorium officials have said.

Liquidity shortages have now ended with the creditability has returned to the peg amid weaker credit, allowing demand to return.

Sri Lanka’s banks came under new accounting rules last year. Rolling over bad loans in the form of new loans has become less easy under new rules, analysts say.

Sri Lanka had experienced two busts in a row due to consecutive credit bubbles fired by pro-cyclical fiscal and monetary policy and real effective exchange rate (REER) targeting, analysts who track the central bank closely have said.

As foreign investors fled faster than earlier, the ability of money printing to boost growth had fallen.

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Double Busts

In 2015, as private credit picked up, the 2015 budget recklessly raised government spending and the central bank printed money mainly by terminating term repo deals, generating a balance of payments crisis which led to a collapse of the rupee from 130 to 150 to the US dollar.

In 2017 the economy stabilized, though credit slowed, rates came down and taxes were raised. The central bank collected forex reserves as credit slowed but the rupee was depreciated despite a balance of payments surplus, Indonesia-style, apparently for real effective exchange rate (REER) targeting.

In 2018, as credit picked up the central bank against printed money, mainly through its lender of last resort facilities and also dollar rupee swaps to generate two runs on the rupee.

Credit at listed banks grew strongly by 4.5 percent, in the first quarter of 2018 data show. But money was printed from around March 2018, generating capital flight and currency collapses.

Unlike in 2015 there was no noticeable pro-cyclical fiscal policy in 2018 and the budget deficit was broadly stable. The finance ministry also started politically difficult market pricing of fuel.

Monetary Dominance

In 2018 instability was driven mainly by monetary policy, critics have said, requiring re-evaluation of earlier ideas that fiscal dominance of monetary policy was to blame for economic instability in Sri Lanka.

The 2018 instability came as banks were still accruing left-over bad loans in the first quarter of 2018, from the 2015/2016 crisis.

In 2018 the rupee collapsed from 153 to 182 to the US dollar and there were prolonged liquidity shortages as bond holders fled. Shortly before the instability analysts had warned the central bank not to repeat earlier errors.

In October President Maithripala Sirisena triggered political crisis, further undermining confidence in the peg.

The central bank has already slapped price controls on deposit rates and price ceilings on lending rates may be on the way.

The rupee has since been allowed to recover to 176 to the US dollar levels by the central bank by end June 2019, restoring a little of the real incomes lost by consumers.

The central bank has also bought dollars to generate liquidity, and mopped up some to re-build reserves, though its peg, generally conducting cautious policy. The floor policy rate was cut by 50 basis points at the last money policy meeting, allowing short term rates to move down.

With weak credit, rates have moved down without printing money (enforcing a ceiling policy rate with liquidity).

There have been calls to reform the central bank or criminalize some of the more reckless domestic operations, reduce its ability to print money, especially when the credit system recovers. (Colombo/June14/2019)