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Sri Lanka’s central bank gives Rs28bn loans from Rs120bn quasi-fiscal Coronavirus re-finance

ECONOMYNEXT – Sri Lanka’s central bank said it had approved 28 billion rupees of subsidized credit to be issued from commercial banks from a re-finance (printed money) which had been increased to 120 billion rupees from 50 billion rupees.

The central bank introduced a 50 billion rupees quasi-fiscal loan scheme for Coronavirus hit businesses and had expanded it after President Gotabaya Rajapaksa summoned Governor W D Lakshman to his office and slammed the agency for not raising it to 150 billion rupees.

“The Central Bank has approved 13,861 loan applications under the Phase-I of this Scheme, totaling Rs. 27.9 billion, out of which the licensed banks have already disbursed Rs. 14.8 billion among 7,274 affected businesses island-wide as of 24 June 2020,” the Regional Development Department of the Central Bank said in a statement.

Re-financed credit from the Regional Development Department had been blamed for monetary instability in the 1980s, with rapid depreciation and inflation making budgets un-manageable and stopped Sri Lanka from getting the full benefits of re-opening the economy in 1978.

The Governor A S Jayewardene, a classical economist, stopped central bank re-finance as part of efforts to stop rapid depreciation and high inflation.

Such re-finance of state banks by the State Bank of Vietnam also led to a contraction of Vietnam’s economy after a sudden boom when it re-opened in 1986. Vietnam’s sustained growth came after SBV reforms and the separation of banks from the central bank.

China also reformed the People’s Bank of China after monetary instability in the late 1980s and 1992 led to steep falls in forex reserves and inflation spiked and the Yuan fell collapsed, until the monetary law was changed to stop re-financing of mainly state enterprises.

Interest rates also fell after the currency chronic depreciation ended.

The central bank said the loans were given below market at 4.0 percent.

“These loans carry a concessional interest rate of 4 percent (p.a.) with a grace period of 6-months and a repayment period of 24-months,” the central bank said.

“Further, the Central Bank now stands ready to provide further Rs. 120 billion at a concessionary rate of 1 percent (p.a.) to commercial banks for on-lending to the affected businesses at a concessionary rate of 4 percent (p.a.) under the Phase-II of the Scheme.”

The central bank itself is giving the loans to commercial banks at 1.0 percent.

The money which will be in the banking system as excess liquidity until it ends up in forex markets as imports will be parked at the overnight window at 5.5 percent, generating a loss of 4.5 percent.

However the higher rate on the deposit window may help the exchange and eventual bad loans by reducing mal-investments.

When the printed money hits the forex markets, the central will have to spend forex reserves to stop the rupee from falling or allow the rupee to fall analysts say. When liquidity is injected a soft-pegged central loses its ability to collect forex reserves unless domestic credit slows.

Amid earlier bout of money printing had already led to a sweeping import controls, not seen since the 1970s controlled economy, where attempts were made to reach self-sufficiency with non-export competitive import substitution.

Sri Lanka is engaging in central bank re-finance despite having problems in repaying foreign loans. Sri Lanka’s forex reserves have been falling steadily since liquidity injections began in late February 2020 after a rate cut in January 2020. (Colombo/June24/2020)