ECONOMYNEXT – Sri Lanka’s commercial banks have raised deposit rates around 200 basis points over the past six months, as credit demand picked up, despite money printing by the central bank to enforce a 50 basis point rate cut earlier in the year.
One year fixed deposit rates in February 2016 range around 8.25 percent to 8.75 percent up from around 6.0 to 6.5 percent in September 2015, according to newspaper advertisement and online announcements.
State-run Bank of Ceylon, People’s Bank, NSB and private Commercial Bank are paying around 8.25 percent for one year deposits.
Seylan and NDB, which saw 20 percent credit growth last year are offering 8.5 percent for 12 month deposits.
Smaller banks are paying higher rates. Newly set up Cargills Bank is offering 8.75 percent. Pan Asia Bank advertised a promotional 10 percent rate for 12-month deposits.
Many banks, including large banks, however are giving as much as 9.0 percent to customers with big deposits who negotiate.
Higher rates are required to curb spending, and generate more resources for credit and investments when budgets go off track and private credit also picks up.
Central Bank data shows that average weighted prime lending rates has also risen about 100 to 150 basis points at most banks.
Sri Lanka’s banks were flushed with liquidity (deposits that were not loaned out) at the beginning of 2015, due to weak credit up to the second quarter of 2014 in the wake of a balance of payments crisis in 2011/2012.
But a sharp hike in state salaries and subsidies in January 2015 pushed up state domestic borrowings just as private credit was picking up, and banks rapidly used up excess liquidity in new loans, which generated imports.
The excess liquidity loanded out was mopped up in forex markets by the Central Bank by spending forex reserves. In April the Central Bank cut rates by 50 basis points despite rising state and private credit, accommodating the fiscal shock.
Economic analysts pointed out that the move was similar to a January 2011 rate cut (the unkindest cut of all), which accommodated a supply shock from drought and a petroleum price spike, triggering a BOP crisis later in the year.
By the third quarter 2015 large volumes of money was being printed in a ‘quantity easing’ style exercise outside the overnight policy rate corridor, replacing lost liquidity with ‘synthetic deposits’ and adding fuel to the credit fire.
In September an attempt to float the rupee failed as money printing and credit growth continued.
But deposits rates began to move up sharply from around October as banks on their own raised rates, generating deposits from real customers to finance credit.
In January a statutory reserve ratio was hiked 1.50 percent, pushing up intermediation costs and reducing the efficiency of the banking system.
An orderly market driven rise in interest rates is required for economic stability and for credit markets to function effectively, though in many countries, central bank try to manipulate rates and get into trouble.
Countries with central banks that do not have a true floating rate and buys foreign exchange to ‘smoothen volatility’ also known as soft-pegged arrangements are the most badly hit when rates are manipulated down.
Steve Hanke, a professor at John Hopkins University writing in the bulletin of the Official Monetary and Financial Institution Forum (OMFIF) where he is an advisor says the focus on low policy rates is misplaced and the Fed rate hike will not harm the US.
"This obsession with the course of the fed funds rate is curious to say the least," he notes.
"Indeed, since the early 1980s, there have been five episodes in which the Fed raised rates. And, in each of these cases, economic growth remained steady or accelerated.
"So, why all the hand-wringing? This is probably a Keynesian hangover. The mainstream macro model that is widely used today is referred to as a ‘New Keynesian’ model.
"The thrust of monetary policy in this model is entirely captured by changes in current and expected interest rates. Money is nowhere to be found."
Hanke says tighter Basle III regulations and Frank-Dodd regulations have pressured bank lending.
"So the US economy looks in a healthy enough state to withstand a modest further
increase in interest rates," he says. "The biggest risk to the US economy is not Fed interest rate tightening, but another round of bank bashing through misplaced regulations.