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Sri Lanka finance companies to be hard hit by import controls as bad loans top 11-pct

ECONOMYNEXT – Sri Lanka’s Finance Companies which have seen rising bad loans as the rate cuts of April 2018 triggered currency collapses, will be continue to be hit due to the latest import control imposed after the 2020 money printing, analysts said.

A regulatory push for further consolidation is also expected by some.

Sri Lanka’s central bank made a pro-cyclical rate cut in April 2018 and injected money through open market operations, amid a so-called buffer strategy to enforce the cuts as credit recovered. In July 2018 more money was injected including through rupee dollar swaps.

A currency collapse and credit downgrade followed.

Monetary Instability

In 2020 more money was printed, and another credit downgrade followed and a trade lockdown involving import restrictions not seen since the collapse of the Bretton Woods system of soft-pegs in 1971 are now in place.

The controls come from a strong belief in Mercantilist doctrine in Sri Lanka where trade rather than money and credit are blamed for monetary instability, economic analysts have said.

Bad loans of the finance and leasing companies which were at 5.82 percent before the April 2018 rate cuts had risen to 11.7 percent by March 2020. Among leasing companies alone bad loans had risen from 2.59 percent in March 2018 shortly before the pro-cyclical rate cuts to 5.42 percent by March 2020.

Since a flexible inflation targeting with a peg (where rates are cut pro-cyclically as the pegged system recovers from a previous crisis and inflation is low after about 18 months of weak or negative credit), currency crises have telescoped to smaller gaps, economic analysts have shwoe

Weak consumption that follows a currency collapses which hit business revenues, which in turn trigger bad loans across the economy. After March 2020 consumption had also been hit by Coronavirus lockdown and there is also an ongoing debt moratorium.

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Hard Stop

Whenever pro-cyclical rate cuts and liquidity injections triggered currency pressure in earlier years, vehicles have been among the first imports to be controlled in Sri Lanka.

Gold, ‘non-essential goods – as determined by politicians and rulers – are other hot buttons.

“At the end of the day they (Non-Bank Finance Companies) are being hit quite a bit by the import controls,” Lakshini Fernando, Vice President Research at Asia Securities, a Colombo-based brokerage said in an online forum by Sri Lanka’s Echelon Magazine.

“When it is a hard stop in imports you are looking at quite a tough time in the months to come for them.”

Provisioning for loan losses will further hit profits.

“You see impairments go up significantly and there is a cost in covering them as well.”

When new loan growth falls or contract, the bad loans as a proportion of total loans tend to rise faster just as central bank financed credit lowers the bad loan rate before the bubble bursts.

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Capital Erosion

Vehicle leasing and finance as well as other equipment are key businesses of finance companies. Some also has a focus on consumer durables.

“And these companies are likely to get multiple hits on the next three or four quarters on a continuous basis,” First Capital, head of Research, Dimantha Mathew Capital said.

“Most of these companies do have a low capital base.”

Mathews said the biggest three or four finance and leasing companies were likely to do better than others.

But their capital and assets have to be monitored closely, he said. It was not a sector that he was recommending to clients.

In the past most finance companies have collapsed due to property related lending and spiking deposit rates, while leasing books have been generally better due to the ability to easily repose and sell them, economic analysts say.

In an economic downturn however sometimes it is not easy to sell re-possessed assets.

With Coronavirus lockdown, when everyone ran out of revenues, a moratorium had been given by the regulators.

Consolidation

Fernando said companies also cannot take back assets in the case of those who had defaulted before the Coronavirus crises.

“Preserving their capital and maintaining their core capital ratios will be their key priorities at this moment of time,” she said.

“What the central bank may do is they will push for further consolidation. It has been on the agenda for a long time. But now the need has come.

She said there was a question whether the big firms would want to buy smaller firms at this time, and there could be an option of consolidating small firms.

She said the firm would try to ride the low interest rates environment and take whatever assistance the central bank is giving. (Colombo/July28/2020)