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Sri Lanka directed credit plans in the oven

ECONOMYNEXT – Sri Lanka’s main monetary policy tool to promote growth are low-interest rates and liquidity in the banking system and directions will be issued soon to direct credit to priority sectors, Central Bank Governor W D Lakshman said.

Sri Lanka was taking action to boost investment in several sectors and dismantle barriers in a bid to push growth up towards 5.5 to 6.0 per cent in 2020, after an estimated 3.9 per cent contraction in 2020.

“Other conditions are created to promote investment,” Governor Lakshman said. “The main monetary policy instrument is the low-interest rate regime and the market liquidity for banks that is providing and also requesting banks to increase their lending for productive activities.”

The Monetary Board at a meeting in March had wanted credit to be channelled to sectors that they thought could generate high growth and those they viewed had potential but were still underfunded.

“Mechanisms to promote this are being examined by the Monetary Board and action will be taken soon in order to implement some of the decisions we will be making,” Governor Lakshman told reporters after keeping the policy corridor unchanged in March 2021.

Sri Lanka has printed unprecedented volumes of money in 2020 to prevent rates from going up after a tax cut and Coronavirus pandemic high state revenues and triggered a 2.3 billion US dollar balance of payments deficit as foreign reserves absorbed the liquidity shock in a pegged exchange rate regime.

“Reflecting the transmission of monetary easing measures taken by the Central Bank in the recent past, both market deposit and lending rates have declined substantially towards establishing a single-digit interest rate structure,” the Monetary Board said in its March policy review.

“Many market interest rates have declined to their historic lows.”

By March the central bank’s Treasury bill stock had topped 800 billion rupees from 69 billion rupees when the money printing bout began.

Money had also been injected through the central bank re-financed loan scheme in 2020.

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However, Sri Lanka has been injecting liquidity in multiple forms since August 2019 reversing earlier prudent policy analysts have pointed out, though weak private credit and higher tax rates moderated monetary instability.

Foreign investors who had been exiting rupee bonds amid a Real Effective Exchange Rate Regime still held over 140 billion rupees of rupee bonds at the time.

Directed lending schemes have been a key feature of Soviet Gosplans, and also Nehru’s five-year plans modelled on them which led to the Hindu rate of growth, monetary instability and foreign exchange controls.

“Economic development is not merely a matter of credit creation or deficit financing,” Indian classical economist B R Shenoy warned (A NOTE OF DISSENT ON THE MEMORANDUM OF THE
PANEL OF ECONOMISTS) at the time.

“As no plan can be bigger or bolder than the available resources, the size of the investment programme should be reviewed periodically to ensure that it keeps within the limits of savings.

“If such a review should reveal a shortage of resources it would be shortsighted to fill the gap by credit creation or deficit financing as this will be self-defeating.”

He advised government-private borrowings to be limited to the actual savings and cash balances generated by the banking system.

In addition to inflating the money supply and triggering external deficits and domestic inflation when loans are given at low rates, many pet projects favoured by bureaucrats and interventionists or other businesses seem to be viable.

When rates are lowered by the rate-setting committees at central banks such as the Federal Reserve also projects are funded which collapse when rates are normalized.

In the US, large volumes of housing loans promoted by the ‘affordable housing’ rule Department of Housing and Urban Development and lowered underwriting standards were for low-income borrowers had worsened the fallout of a ‘mother of liquidity bubbles’ fired by the Fed, some critics have said.

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