ECONOMYNEXT – Sri Lanka’s interest rates are high and hurting small businesses in particular but interest rates are required to maintain stability, President Ranil Wickremesinghe said.
“One is, all of you want to know what’s going to happen to the interest rates?,” President Wickremesinghe told an economic policy forum organized by the Ceylon Chamber of Commerce.
“I wish I know. The governor has told me that the inflation has peaked. It’s coming down. You all understandably want some relief with the interest rates to carry business on.”
“I understand that and appreciate the viewpoint. It’s not easy to carry business on with such high interest rates. On the other hand, the Central Bank also has to handle the economy. So maybe sometimes early next year we will have a meeting of minds of both these propositions.”
Sri Lanka’s interest rates are currently at around 30 percent but not because the central bank is keeping it up. The central bank’s overnight policy rate is only 15.5 percent but the requirement to finance the budget deficit and roll over debt is keeping rates up.
Rates are also high due to a flaw in the International Monetary Fund’s debt workout framework where there is no early clarity on a whether or not domestic debt will be re-structured.
After previous currency crises, rates come down after an IMF deal is approved and foreign loans resume and confidence in the currency is re-stabilished following a float.
This time however there has been no clear float, though the external sector is largely stable and foreign funding is delayed until a debt re-structure deal is made.
Sri Lanka’s external troubles usually come because the bureaucrats do not believe market rates are correct when credit demand picks up and mis-uses monetary tools given in 1950 by the parliament to suppress rates, blowing the balance of payments apart.
The result of suppressed rates by the central bank are steep spikes in rates to stop the resulting currency crisis.
A reserve collecting central bank has little or no leeway to control interest rates (monetary policy independence) without creating external troubles, which is generally expressed as the ‘impossible trinity of monetary policy objectives’.
However, it has not prevented officials from trying repeatedly to suppress rates, perhaps expecting different results.
After suppressed rates – supposedly to help businesses – trigger currency crises, the normalization combined with a currency collapse leads to impoverishment of the population.
The impoverishment through depreciation leads to a consumption shock, which also leads to revenue losses in businesses.
The suppressed rates then lead to bad loans.
In the 2020/2022 currency crisis the sovereign default has also led to more problems at banks. Several state enterprises also cannot pay back loans.
“…[T]he bad debt that is being carried by the banks is mainly from the private sector or the government sector,” President Wickremesinghe said.
“Keep the government sector aside. We’re dealing with it. How do you handle it? Look, one of our major areas of are the small and medium industries. You can’t allow them to collapse, but they’re in a bad way.”
Classical economists and analysts have called for new laws to block the ability to central bank to suppress rates in the first place so that currency crises and depreciation does not take place in the first place.
Then politicians like Wickremesinghe do not have to take drastic and unpopular measures to fix crises and there will be stability like in East Asia.
Sri Lanka had stability until 1950 when the central bank was created by abolishing an East Asia style currency board. The currency board kept the country relatively stable through two World Wars and a Great Depression.
In 1948 after the war (WWII) was over “we stood second to Japan” Wickremesinghe said.
“But we started destroying it from the sixties and the seventies,” he said. :We started rebuilding an economy, which was affected by a (civil) war, and thereafter the way we went, is best not described here.”