Sri Lanka blames high interest rates on ‘structural issues’

sri lanka rupee notes coin

ECONOMYNEXT – Sri Lanka has blamed ‘structural issues’ for high interest rates in the country, as large volumes of money was printed through multiple lender of last resort windows near policy deposit rates to force interest rates down.

“The reason for no (credit) demand in our view is market rates are relatively high in 14-15 percent when inflation is around 4-5 percent and economic growth is around 3-4 percent, so nominal growth is around 8 percent,” Central Bank Deputy Governor Nandalal Weerasinghe told reporters.

“If businesses’ incomes are growing at 8-9 percent then it is going to be difficult for them to service a loan of 14-15 percent,” he said.

“This is the kind of structural issue we are addressing now in a low inflation environment.”

“But if we had high inflation like in the past, then servicing a loan of 14-15 percent is not a challenge because nominal incomes are growing at 18-20 percent, so they can service that.”

The central bank cut rates in May 2019 without printing money but in August money was printed to push down rates.

The central bank has slapped price controls on deposits and is planning controls on lending rates.

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Sri Lanka’s currency collapsed from 153 to 182 to the US dollar in 2018, which came quickly on top of another collapse from 131 to 150 in 2015/2018.

But inflation has not been as high as that experienced in the 1980s and in the run up to the burst US credit and commodity bubble in 2008.

Prices have been partly helped by relatively stable global commodity prices backed by better US policy, as well as tighter policy domestically in the form of liquidity shortages, analysts have said.

In Sri Lanka as well as other countries, bouts of money printing and currency collapses are usually followed by credit collapses. Similar credit slowdowns have occurred in the wake of currency collapses in 2008, 2012 and 2016.

So-called ‘Keynesian stimulus’ with deficit spending is advocated to counteract a private credit collapse which takes time to recover.

But in countries with pegged exchange rates, such spending, if accommodated with money printing, can lead to fresh collapses of the currency.

Analysts have pointed out that countries with monetary instability and currency collapses tend to have high nominal interest rates.

In Sri Lanka at one time budget deficits were blamed for high interests, but deficits have fallen in recent years.

In the first half of 2019, the budget deficit widened as revenues fell due to currency and credit collapse, as well trade restrictions slapped by the central bank in the course of operating a s-o-called ‘flexible exchange rate’ backed by conflicting money and exchange policies.

However up to June, most of the deficit had been filled by foreign borrowings.

In Sri Lanka deficits have also been blamed for high inflation, though in the absences of central bank accommodation (money printing) deficits simply crowd out private credit.

Alleged inefficiencies in the banking sector, and high margins have also been blamed for high interest rates.

Other analysts however have noted that countries with monetary instability and currency collapses tend to have high nominal interest rates and volatile inflation.

Countries with strong currencies and countries with central banks that follow consistent pegs or consistent floating rates, tend to have low nominal interest rates.

There have been calls for central bank to end monetary instability that has dogged the country for nearly 70 years since the soft-pegged central bank was set up. (Colombo/Sept06/2019)

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