Private credit in Sri Lanka turns negative after four years in Jan 2019

ECONOMYNEXT – Sri Lanka’s credit to private borrowers from commercial banks turned negative in January 2019 for the first time since 2014, official data showed in the wake of two currency collapses in 2018 and a political crisis in the last quarter.

Private credit was last negative in May 2014.

The rupee stabilized in January.

Weak credit allows the central bank to purchase dollars exercising its strong side convertibility undertakings and mop up inflows, shrink the external current account and build reserves by keeping the system slightly tighter than a free market peg (currency board).

Credit Slowdown

Outstanding private credit fell 4.3 billion rupees from 5,561.4 billion rupees in December 2018 to 5,557.1 billion rupees in January 2019.

Credit to state enterprises also contracted 44.3 billion rupees to 711.1 billion rupees, for reasons that are not clear.

Total credit to government rose 110.2 billion rupees in January, including 43.7 billion rupees in central bank credit.

Central bank credit expanded 43.7 billion rupees to 515 billion rupees in January from 471.3 billion rupees in December with the monetary authority using part of its forex reserves to part settle a billion US dollar bond in January 2019.

In Sri Lanka the way central bank reserves are appropriated do not cause pressure on the currency (monetary policy neutral) as the transaction goes through one bank without affecting reserve money.





Currency Collapse

Sri Lanka rupee fell from 153 in January to around 161 by August as the central bank stopped sterilization auctions in February 2018 and printed tens of billions of rupees to enforce a rate cut in April as well as re-finance a so-called ‘buffer strategy’.

From February to 2018 to end April 2018, central bank credit rocketed from 225 billion rupees to 291.3 billion rupees. The rupee ended up at 161 to the US dollar in the first run.

In the second run central bank credit rose from 245 billion rupees in August to 471 billion rupees by December. Part of the money was printed after pressure was triggered on the rupee after defending the currency when capital flight intensified during a political crisis.

President Maithripala Sirisena, appointed Mahinda Rajapaska as Prime Minister suddenly and illegally suspended parliament, harming foreign investor confidence.

The rupee fell to 182 by the end of the year.

With private credit slowing or contracting, pressure went off the rupee in January. Meanwhile the central bank has bought dollars in 2019.

But it also allowed the rupee to appreciate in 2019. It takes longer for a country recover from a credit contraction when the currency also falls.

After the 1997-98 East Asia crisis, Hong Kong which had a currency board (hard peg with floating interests) was the first to recover with its gross domestic product reaching pre-crisis levels by 1999.

Monetary Instability

Sri Lanka’s soft-pegged central bank is a key challenge to the country’s progress, which has been printing money and generating instability since it was set up in 1950.

Money printing causes cascading expansion in credit pushing imports up and making dollar outflows exceed inflows, leading to pressure on the pegged exchange rate.

The central bank prints money to cut the rate weakening the peg (pushing the peg from the strong side of its convertibility undertaking to the weak side) but does not allow rates to float to bring the peg back to the strong side.

It then injects liquidity and fnally raises rates when instability worsens and after the rupee has fallen in a strategy dubbed ‘rawulath ne kendath ne’ by critics.

In 2019 however the central bank injected most money through term auctions which may have allowed the crisis to end faster.

In Sri Lanka authorities are driven by Mercantilism and believe that balance of payments troubles comes from imports and not by money printing and credit.

Analysts have also faulted the International Monetary Fund for giving Sri Lanka a forex reserve target (with an implicit strong side convertibility undertaking) but no commensurate ceilings on domestic assets to block money printing and keep the peg on the strong side.

In 2017 the central bank wantonly pushed its convertibility undertaking from 150 to 153 rupees to the US dollars based on a real effective exchange rate targeting strategy despite the peg being on the strong side. (Colombo/April01/2019)

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