• CB to consult with banks on reductions and timelines

• Insists on lending rate caps unless rates reduce by about 200 bps

• Defends move as essential to correct systemic issue and push growth

• Says caps will not affect profit margins on banks

• 2Q growth estimated to be just 2.1%

• Credit growth slows to 7.7% in July, lowest since Dec. 2014

• Jan-July cumulative increase was Rs. 42.5 b
  
   

By Uditha Jayasinghe

Unless the Central Bank sees lending rates reducing, it will impose lending rate caps on each financial institution, Governor Dr. Indrajit Coomaraswamy warned, following an unexpected relaxing of monetary policy last Friday, insisting such a measure was necessary to spur growth.

The Governor speaking to reporters after the announcement of a surprise 50 basis point rate cut defended the possibility of the Central Bank imposing a lending rate cap as an effort to address a systemic problem in the financial system, which he said was chocking growth. 

He emphasised that the Central Bank would consult individual banks to decide how they could reduce interest rates and establish a timeline but if lending rates did not start trending downwards in the next few weeks the Monetary Board would not hesitate to take action, he said. “The Central Bank will work with the stakeholders, will consult them to determine the timeline and the measures that will be taken. Any imposed caps would be distortionary and not something the Central Bank is keen to do but if one sees this rigidity in lending rates continuing, the Monetary Board has decided it will take action.”

Given the repeated relaxing of policy rates there should be a “more material impact on interest rates than we have seen so far and the Monetary Board is determined to see that happen”. Overall the Central Bank hopes to see a reduction of lending rates by 200 basis points.

Private sector credit in absolute terms, declined marginally by Rs. 1.2 billion in July 2019 after a significant increase of Rs. 63.2 billion in June 2019. 

Cumulative increase during the first seven months of 2019 was Rs. 42.5 billion. Year-on-year growth of credit further moderated to 7.7% in July 2019 in comparison to 8.7% in June 2019. This is the lowest growth rate witnessed since December 2014.

A sectoral distribution of private sector credit shows a deceleration in credit growth (y-o-y) to the agriculture, industry and services sectors in the second quarter of 2019. However, y-o-y growth of personal loans and advances accelerated.

Broad money (M2b) growth decelerated to 8.2% (y-o-y) in July 2019 from 8.7% in June 2019 recording the lowest growth rate since December 2008. Net Domestic Assets (NDA) of the banking sector expanded by Rs. 12.1 billion mainly due to an increase in net credit to the Government. Net Foreign Assets (NFA) of the banking sector expanded by Rs. 5.5 billion with the expansion in NFA of the Central Bank.

Interbank rates and Government security yields have declined substantially Average Weighted Call Money Rate (AWCMR) declined by 120 bps so far in 2019 while yields of Government securities declined by more than 200 bps across all tenures thus far in 2019, although some pressure on yields has been witnessed in the most recent auctions.

Market deposit rates continued to adjust downward. Average Weighted New Deposit Rate (AWNDR) declined by 266 bps from end April to 8.58% in July 2019 while the Average Weighted New Fixed Deposit Rate (AWNFDR) declined by 269 bps from end April to 8.88% in July 2019.  The Average Weighted Deposit Rate (AWDR) for Aug 2019 (based on July data) declined by 24 bps from end April to 8.73% and the Average Weighted Fixed Deposit Rate (AWFDR) for Aug 2019 (based on July data) declined by 41 bps from end April to 10.74%.

However, all market lending rates, including the AWPR, are yet to show a downward adjustment commensurate to the decline observed in deposit interest rates, data from the Central Bank showed.

“The Central Bank will continue to monitor market lending rates. Clearly a great deal has been done to relax monetary policy and that needs to be transmitted to market lending rates. That we have not seen. As you know there was a deposit cap placed, which is reducing the financing cost of banks, so there should be lower lending rates. So far it has not met the expectations of the Monetary Board. The Monetary Board took the decision to closely monitor what is happening to market lending rates and if necessary they would impose appropriate caps on market lending rates of individual financial institutions, if the intended reduction is not realised within specific timelines,” the Governor said.

Given that the Monetary Board has relaxed policy rates twice this year it will now proceed to take stock of how monetary policy should evolve in the future and pay special attention to possible fiscal slippage and global developments.

Central Bank officials pointed out that one reason for the lack of private sector credit demand could be low growth and low inflation, which would result in the average growth rate of a business being about 8%. In such an environment borrowing at 14%-15% interest rates is unfeasible. Describing it as a structural issue that can materialise in a low inflation environment, they opined that if lending rates reduce, that would also shrink the non-performing loan ratios of banks.

“We will talk to the banks, we will work out the timeline, how much we expect interest rates to come down by. If they don’t work within those parameters and if they don’t meet those targets, then we are going to impose caps on individual banks. Not asking banks to bring down their margins but to pass down the reduction to the customer,” Senior Deputy Governor Nandalal Weerasinghe said.

A number of reasons were given for the reduction in policy rates including dovish monetary policy among major central banks and reduction of interest rates in key emerging market economies as well as the Sri Lankan economy continuing to have a stubborn output gap. 

The Central Bank believes the local economy has the capacity to grow by 5% but projected growth for 2019 is just 3.1%. To make matters more serious the Central Bank expected second quarter growth to be about 2.1% following the Easter Sunday attacks.  

“On the external front we have seen a significant contraction of the trade deficit, which has come down by $ 2 billion in the first half of the year, and we originally projected the current account deficit would be 3.2% this year, which was changed to 2.6% after the Easter Sunday attacks but our latest thinking is that it may come out even better than 2.6%.”

Dr. Coomaraswamy acknowledged that even through the rupee has come under pressure in the last few days, this was unlikely to continue as market fundamentals remained strong.   

“The rupee has appreciated by about 1.8% this year but in recent days there has been pressure in the foreign exchange markets. The underlying fundamentals do not really explain this pressure so we expect it to be short-lived. Where the pressure is coming from is capital flows and we have about $ 700 million of foreign institutional investment in the rupee securities market; even if all of that goes out, it won’t, but in the worst case scenario, reserves are at $ 8.4 billion and we will end the year at about $ 8.2 billion. Even if the $ 700 million goes out we have the reserves to counter it,” he added.  

He conceded that fiscal slippage was possible as Government revenue was affected by the Easter Sunday attacks but was confident such a situation could be managed as other fundamentals remained strong.   

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