ECONOMYNEXT – Sri Lanka’s private credit expanded 60.7 billion rupees in May 2024, reversing a contraction in April, while credit to state enterprises were flat, official data showed.
Sri Lanka’s private credit has expanded only 71 billion rupees over the first five months of May 2024, amid low inflation and easing import prices, as well as stable exchange rate, which may lead to importers using supplier’s credit.
Domestic demand is just starting to pick up amid low or falling inflation, with some private sector salaries increased – which is seen in PAYE tax receipts – which will eventually lead to a recovery in consumption and later to investments in capacity expansion.
Though the central bank has not cut rates with inflationary operations up to May, excess liquidity built up to around 200 billion rupees by the end of the month from dollar purchases.
Initial pressure on the currency – and inflation – generally comes from private and state enterprise credit, which drive imports and not necessarily government credit, which is based on largely domestic expenditure in the first round.
Rolled over interest costs, for example is largely a paper transaction which has no effect on reserve money or inflation, unless attempts are made to use ‘cash buffers’ to de-stabilize the credit system, analysts say.
In May net credit to government was measured as a negative 75.1 billion rupees with central bank credit measured as a negative 89.1 billion rupees.
However, the net numbers come partly from unsterilized excess liquidity deposited in the central bank overnight (or term), which banks can use to clear transaction or lend the following day (or as soon as the term deal ends) surged to close to 200 billion rupees by the end of the month.
The excess liquidity came from dollar purchase up to May, amid confidence in the currency.
The rupee came under pressure in June after the pick up in private credit and a so-called ‘flexible exchange rate’ where the rupee is allowed to fall after dollar purchases, triggering confidence shocks to the currency markets and higher than needed shocks to interest rates markets as well, analysts say.
The central bank withdrew some of the excess liquidity in June, but very short term rates were held with injections, leading to higher-than-required gilt yield rises to correct the confidence shock to the currency, analysts say.
Analysts have warned that under the current operational framework (printing money for inflation through flexible inflation targeting, and printing money for growth through potential output targeting) could lead to external imbalances regardless of fiscal corrections as happened after the end of a 30-year civil war and lead to a default on restructured bonds when private credit picks up.
Private credit is still weak.
(Colombo/June14/2024)