Sri Lanka holds policy rates, raises red flag on SOE credit

ECONOMYNEXT – Sri Lanka kept rates unchanged in June, but the Central Bank raised a red flag on rising borrowings by state-owned enterprises, although central government revenues were improving.

"The recent expansion in credit obtained by state-owned business enterprises poses a risk to the behaviour of overall domestic credit, reflecting the need to address concerns in relation to the financial performance of key SOEs," the Central Bank said in its June monetary policy statement.

Credit to SOEs rose to 557 billion rupees in April 2017 from 495 billion rupees in December 2016 as oil prices rose and a drought forced more thermal generation of electricity, reversing a trend of a net payback in loans seen up to the third quarter of 2016.

However, since May, oil prices have begun to ease, though they remain at much higher levels than in 2016.

Sri Lanka is still gripped by a drought and does not have a mechanism to adjust energy prices.

The lack of a price formula for fuel and the frequent adjustment of electricity prices pose threats to the credit system, the economy and the exchange rate, economists have pointed out.

However, private credit was slowing now, and better revenue collection was also helping reduce central government borrowing.

"The growth of credit to the private sector continued to decelerate gradually," the Central Bank said. "A further deceleration in growth of credit to the private sector is anticipated, given the prevailing high nominal and real lending rates in the market."

"The continuation of the government’s revenue-based fiscal consolidation process and inflows to the government on account of foreign borrowings appear to have reduced the pressure on interest rates in the government securities market substantially."

The Central Bank was keeping the rate at which money is printed overnight for banks at 8.75 percent and the rate at which excess money is taken back at 7.25 percent.





Slower credit growth and the ending of money printing has allowed the Central Bank to collect foreign reserves. By mid-June, foreign reserves topped 7.0 billion rupees. The rupee has fallen 2.3 percent against the US dollar up to June, helping generate inflation. However, 12-month inflation slowed.

"As the impact of the revisions to the tax structure and weather-related supply disruptions is expected to dissipate in the period ahead, inflation is projected to moderate to mid-single digits by the end of 2017, and stabilise thereafter," the Central Bank said.

Sri Lanka’s economy grew 3.8 percent in the first quarter, with bad weather hurting agriculture and electricity generation.

"Growth in the first quarter was weighed down by the impact of unfavourable weather conditions, particularly on agriculture-related activities," the statement said.

"The performance of industry-related activities was largely driven by the continued expansion in construction, while services-related activities recorded moderate growth. The economy is expected to recover during the second half of the year." (Colombo/June23/2017 – Update III)

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