Sri Lanka credit to state surges in January 2015, amid private loan growth

COLOMBO (EconomyNext) – Sri Lanka’s credit to the state from commercial banks as well as printed money from the Central Bank which results in later forex reserve losses, had risen sharply in January 2015, official data shows.

Credit to private borrowers rose 21.0 billion rupees in January, down from an unusual December peak of 76.5 billion rupees and also down from the 40 to 50 billion rupee pace seen since a recovery in credit from August.

The Central Bank said in a monetary policy statement in April expanded 24.5 billion rupees in February making no mention of state credit in that month.

Sri Lanka had Presidential elections in January which led to a change of regime and a minority administration ahead of parliamentary election expected later this year.

Political uncertainty has also increased after a budget in January 29 hit companies with retrospective taxes and later the ministry of trade started slapping price controls particularly targeting small and medium enterprises including hopper makers.

In January credit to the state from the banking system rose 121.6 billion rupees including 91.2 billion rupees in Central Bank credit or printed money. In January the Treasury repaid a 500 million US dollar bond with forex reserves, which makes domestic assets of the Central Bank rise as it acquires Treasury bills.

Under Sri Lanka’s flawed Central Bank law, the monetary institution is forced to give a printed money overdraft to the government known as a ‘provisional advance’ which adds to money supply expansion and later foreign reserve losses, unless the cash is permanently mopped up quickly.

The Central Bank may also transfer profits in the form of domestic money, which will also add to domestic demand and later foreign reserve losses when the demand hits the balance of payments via import demand.

Analysts have called for the provision to be abolished as part of central bank reform and existing provisional advances to be converted to Treasury bills which can be sold in the market to sterilize liquidity and build-up foreign reserves.

Sri Lanka’s state finances are expected to have worsened after January when salary increments and other handouts came from a revised budget.

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Additional spending especially salaries will increase domestic demand, and with insufficient time for a supply response, put pressure on the balance of payments as Keynesian stimulus usually does, except when private credit is negative.

In February and March the government started to borrow more from the sales of Treasury bonds which will can help reduce the negative impact on the balance of payments.

However if the bond bonds dip into excess liquidity in the banking system, more foreign reserve losses can be expected, in the same way the actual central bank credit generates excess demand.

Credit to state enterprises also rose 22.9 billion rupees in January, pointing to a continued deterioration in their finances.

Key state enterprises include the Ceylon Electricity Board, Ceylon Petroleum Corporation and SriLankan Airlines.

Finances of energy utilities can deteriorate either due to actual losses from price reductions or delayed payments from state customers such as SriLankan Airlines or other government departments.

Total credit extended from the banking system including printed money rose to a high of 165 billion rupees in January, higher than the 140 billion rupees hit in January 2012, shortly before the rupee was floated and interest rates raised.

In any month, if total credit from the banking system exceeds deposit creation through inflows, there can be net negative pressure on the balance of payments.

Sri Lanka’s foreign reserves fell from 8.2 billion US dollars in December to 6.8 billion US dollars in March.

Updated – Paragraph 4 expanded to explain reserve appropriation to settle foreign loan.

In January credit to the state from the banking system rose 121.6 billion rupees including 91.2 billion rupees in Central Bank credit or printed money. In January the Treasury repaid a 500 million US dollar bond with forex reserves, which makes domestic assets of the Central Bank rise as it acquires Treasury bills.

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