ECONOMYNEXT – Sri Lanka credit from banks to the private borrowers expanded by 74 billion rupees in June to 7,512 billion rupees, after also expanding 61 billion rupees in May, central bank data showed.
When a central bank which does not have a clean float and cuts rates enforced by reverse repo and term reverse repo injection and triggers an external crisis, rates have to be steeply hiked to correct the confidence shock to its note issue (domestic currency).
As rates go up and currency deprecation destroys, purchasing power, business lose customers, stop expanding and try to repay loans.
The contraction in credit stabilizes the currency, but businesses do not make expansion plans until inflation stabilizes and demand recovers.
The central bank has so far not cut rates precipitately.
But under all IMF programs since the end of a civil war rates have been cut just as private credit recovered, triggering a new cycles of external stability, missed reserve targets and depreciation which pushes up energy and food prices, social unrest, losses in energy utilities.
The central bank in a July monetary policy statement cut rates by 25 basis points to 9.25 percent, after providing monetary stability for almost two years.
“The Board underscored the need to signal its desire to continue eased monetary conditions to sustain the revival of economic activity towards the full potential, in the absence of significant inflationary pressures,” the central bank said in its July statement.
“Accordingly, financial institutions are expected to transmit the benefit of policy easing thus far by continuing.”
By cutting rates with liquidity injections, based on mathematical models, flexible inflation targeting central banks deny monetary stability for people and businesses to operate and also import goods.
“Meanwhile, the Sri Lanka rupee witnessed intermittent volatility against the US dollar in recent months,” the central bank said.
“Overall, the Sri Lanka rupee appreciated by over 6.5 per cent against the US dollar thus far during 2024.”
After a spike in excess liquidity in May and some reverse repo injections the rupee came under some pressure in June amid a recovery in private credit.
Sri Lanka still has import controls and has had exchange controls for decades, indicating that there is a deeply flawed operational framework, that hinders free trade and cross border flows, analysts say. (Colombo/july24/2024)