ECONOMYNEXT – Sri Lanka will establish a ‘permanent single digit interest rate structure’ in the country, which will benefit the business community, Central Bank Governor W D Lakshman said.
“Capitalising on the achievement of 12-years of single-digit inflation, the Central Bank intends to establish a permanent single digit interest rate structure in the economy,” Governor Lakshman said delivering a 2021 policy roadmap through a virtual address.
“We will remain focused on maintaining market interest rates at single digit levels going forward.”
“The business community will benefit from low-cost borrowing facilities corresponding to a low interest rate regime.
“This is imperative to promote investment and entrepreneurship in the country, the needed foundation for sustained high economic growth.
“The availability of low-cost funding on a sustainable basis would encourage businesses, including start-ups, to venture into new industries and sectors that have high growth potential.”
Sri Lanka’s private credit fell in 2020, reducing credit demand, while savings also picked up amid Coronavirus induced consumption fall, allowing rates to fall despite a bigger budget deficit.
The central bank also cut its reserve ratios or the share of deposits that banks should keep with the central bank, which tends to drive up costs and lending rates.
Countries that have a working monetary regime involving a pure floating rate or a firm fairly credible peg with around 2 percent inflation tend to have mid single digit interest rates.
But countries that print money and depreciate their currencies tend to have high interest rates and monetary instability.
When Sri Lanka’s money printing central bank was set up in 1950, Treasury bill rates were below 1 percent. By the 1970, amid very tight exchange and trade controls amid money printing, Treasury bill rates were around 5 percent, the levels now seen.
The central bank had also printed large volumes of money, most to fund the government. Government finances were de-stabilized by a steep value added tax cut for ‘stimulus’ in December 2019 and weak activity in 2020.
“The consequent increase in the Government’s revenue-expenditure gap was naturally financed by the Central Bank,” Governor Lakshman said.
Excess liquidity has been about 20 to 25 percent of defined reserve money, and there has been a steady erosion of forex reserves through the financial account.
Governor Lakshman said it was to promote credit.
“Meanwhile, the Central Bank allowed an elevated level of excess liquidity to remain in the domestic money market with a view to inducing a further expansion in credit to the private sector,” he said.
“Most lending rates, which were at double digit levels, reduced substantially, resulting in a decline of average new lending rates to single digit levels, thus enabling the economy to derive the full benefit of single digit inflation maintained for over a decade.
“A gradual increase in credit extended to the private sector was observed in recent months, while credit to the public sector recorded an extraordinary increase, thus leading to a substantial increase in money supply during 2020, playing its countercyclical role amidst the pandemic driven economic contraction.”
Sri Lanka’s growth in 2020 is expected to contract 3.9 percent, he said, and monetary policy in 2021 would be ‘accommodative’ for growth, he said. (Colombo/Jan04/2020)