ECONOMYNEXT – Sri Lanka’s construction sector non-performing loans which peaked at 17.1 percent after a currency collapse, has eased to 14.1 percent despite a contraction in credit, according to the central bank data in a Financial Stability Review.
Construction investment credit is usually one of the big beneficiaries when central banks print money to target inflation or growth and collapse as soon as a ‘stabilization crisis’ starts as inflation ceases to accelerate.
Central banks typically ‘cut rates’ by printing money through open market operations, buying back government bonds from banks, allowing them to give loans without deposits. The exercise tends to worsen loan to deposit ratios.
In the last crisis however some foreign banks, sharply curtailed all credit, including interbank lending due higher risk perceptions including on government debt, where an actual default or induced artificial default from debt restructuring was feared.
Currency Crisis
In a reserve collecting central bank, forex market interventions by foreign reserve sales (or using swap proceeds) are automatically offset with new open market operations money, when there is a policy rate, preventing banks from curtailing domestic credit to match the ouflow of reserves, worsening a currency crisis.
Central bank data shows that absolute volumes of sector loans, especially for residential construction continued to grow, despite rate hikes in 2022.
People who start to build houses, somehow to try to finish construction, using approved but undisbursed loans, even as building materials rocket up due to the collapse do the ‘flexible’ exchange rate and bank give loans with the new money.
Though banks have statutory reserve ratios (SRR) which is supposed to make banks give in loans a little less than they get as deposits, though OMO, they can give more loans that they get as deposits in a day.
In the stabilization crisis that follows inflationary rate cuts, most of the credit financed by OMO goes bad, especially if there is a pegged exchange rate (flexible exchange rate) which collapses, leading to a bigger consumption contraction, where lower income people may find it difficult to eat.
Rocketing prices of construction material as well as falling disposable incomes put off people from new construction.
Meanwhile the central bank said credit to the construction sector, which was 14.1 per cent of the total credit portfolio of the banking sector, contracted 8.2 percent at end the second quarter of 2024 compared to a credit growth of 1.0 percent at the end of the second quarter of 2022.
The Construction sector was highly concentrated on residential construction activities and contracted by 183.3 billion rupees during the quarter ending Q2, 2024.
“Nevertheless, a certain improvement in residential construction activities is expected in the upcoming periods along with declining cost of funds, downward adjustments in prices of construction materials, and revival of economic activities,” the central bank said.
Bad Loans
NPLs of the Construction sector contracted by 20.0 per cent during the year ending Q2 of 2024.
The NPL Ratio of the sector improved to 14.9 per cent at end Q2 of 2024 from 17.1 per cent at end Q2 of 2023.
However, the NPL Ratio of the sector remained relatively high compared to several other economic sectors.
In the last crisis, as the central bank prevented maturing government securities from being rolled over through outright purchases, injecting large volumes of new liquidity.
Banks were asked to mortgage loans at 7 percent which will be fixed for 5 years and will then be priced at prime rate plus 1 percent .
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Sri Lanka 7-pct mortgage loans for houses, land, apartments, renovation
Modern central banks have absolute powers to not only mis-target rates (mid-corridor or single policy rate) but also to direct credit, de-stabilizing currency pegs and for what is generally called macro-economic policy or stimulus.
The OMO, where money is injected indiscriminately into banking systems as well as the fixed policy rate was accidentally invented by the Federal Reserve in the 1920 in the course of triggering the roaring 20s bubble.
The stabilization crisis that followed was called the ‘Great Depression’.
A central bank will usually buy back government securities that banks bought in earlier years (to finance past deficits) in open market operations, but macroeconomists who enforce policy rates usually blame current year deficits probably because politicians are an easy target, critics say.
One of the highest bad loans were seen in the hotel sector of about 40 percent, which was hit by the Coronavirus pandemic and also the currency collapse of 2022 as energy shortages and power cuts came from forex shortages coming from open market operations and sterilization of interventions.
As a share of total loans however, tourism sector was only 3.8 percent.
“Furthermore, the Manufacturing, Trade, and Construction sectors, which each represented more than 10 per cent of credit of the Banking sector, also displayed high NPL Ratios, manifesting that the default risk has spanned through multiple important economic sectors of the country,” the report said.
The bad loans in the stabilization crisis can lead to collapse of banks. Unemployment also goes up.
In Sri Lanka there was a rush to get passports and flee to counntries with currency-board like regimes in the Middle East or two percent inflation targeting countries with a floating rate.
In Sri Lanka the full employment policies hit the country like a sledge hamme after the International Monetary Fund gave technical assistance to calculate a ‘potential output’, critics have pointed, triggering serial currency crisis and an explosion of foreign debt.
“This manufacture of unemployment by what are called ‘full employment policies’ is a complex process,” Austrian economist Friedrich Hayek explained a few years after the collapse of the Bretton Woods system from the policy rate.
“In essence it operates by temporary changes in the distribution of demand, drawing both unemployed and already employed workers into jobs which will disappear with the end of inflation.
“What will happen during a major inflation is illustrated by an observation from the early 1920s which many of my Viennese contemporaries will confirm: in the city many of the famous coffee houses were driven from the best comer sites by new bank offices and returned after the ‘stabilization crisis’, when the banks had contracted or collapsed..”
(Colombo/Oct14/2024)