Sri Lanka central bank says rising credit a concern; policy rates kept low

ECONOMYNEXT – Sri Lanka’s Central Bank kept policy rates unchanged at a near historic low but said for the first time that rocketing credit "has raised some concerns" picking out motor vehicle imports in particular.

"The expansion in private sector credit in the first half of the year was largely due to higher disbursements of credit to the Industry and Services sectors," the Central Bank said in its August monetary policy statement.

"Nevertheless, the rapid increase in the imports of consumer durables including motor vehicles driven by credit available at low interest rates, among other things, has raised some concerns.

Private credit grew 19.4 percent in the year to June 2015, up from 17.6 percent in May 2015, the Central Bank said.

Analysts have warned since early this year that Sri Lanka’s recovery in private credit and an expanding budget deficit needed a policy rate rise and that interest rates in the country was incompatible with the expanding budget deficit.

After a rate cut in April, capital flight added to the budget deficit woes.

"The Central Bank is closely monitoring these developments in order to ensure that credit continues to be available to support productive economic activity while avoiding excessive expansion in credit in the period ahead," the statement said August 31.

In the past the Central Bank has targeted car imports, after keeping rates low with printed money and generating balance of payments crises, in a bid to cherry pick credit disbursements through administrative measures and second guess the needs of private citizens.

In June 55 billion rupees of private credit was disbursed the Central Bank said.

Analysts say the broader malaise is the massive liquidity releases of nearly 300 billion rupees over the past year and the monetizing of 91 billion rupees of government debt over the last two months, generating demand which is spilling over to the balance of payments that is the real problem.

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Last week reverse repo auctions were started to print money overnight and sterilize foreign exchange sales. On August 31, excess liquidity dropped to 25 billion rupees from 33 billion a day earlier.

On September 01, a 79 billion rupee bond tranche is maturing, of which only a little over 60 billion has been rolled over so far, raising concerns over further monetization.

The Central Bank said foreign reserves were at 6.8 billion US dollars in July of which 400 million was a borrowing from the Reserve Bank of India through a swap. The Central Bank said it could borrow another 1.1 billion US dollars from RBI to boost eserves.

Liquidity and domestic asset changes in August was around 60 billion rupees, or the equivalent of over 400 million US dollars, data shows.

The Central Bank said it was keeping policy rates unchanged as inflation was low at 0.2 percent, through core inflation was edging up.

Though policy rate are kept unchanged, auction rates in gilt markets have been allowed to move up, which analysts say will help the economy adjust to credit demand.

Analysts had warned that the longer policy is kept loose the greater the correction measures that would be needed and the further the currency will fall. (Colombo/Aug31/2015)

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