How justifiable is the ceiling of 18% on loan growth?

The country has entered into an era that was not witnessed for past 25 years. Growth rates of the economy cannot even be compared during this period as the ground situation in micro terms have changed drastically that was never before during a quarter of a century. The volatility and events of macro factors make the comparability even more non-realistic.

The arguments or statements of the economy being ‘over heated’, ‘growing at an unhealthy pace’ or to that effect are the results of an incomprehensive comparison of periods as that of comparing apples with oranges.

For over 25 years, the Sri Lankan economy was in a submerged limbo. Halfway through year 2009, the people of this country were able to come to terms with life. The fruits of this grip of the economy are now surfacing; though a few see it as an over-heating, but should have been the norm of a healthy economy.

Credit ceiling

With this misconception, various measures are being implemented to curb or cool the economy, one of which is imposing a limit on credit growth at a ceiling of 18% for the year 2012. The 18% growth is limited to 24 odd banks in an economy that has over 75 registered (formal) institutions involved in lending business apart from unregistered pawn brokers.

The CBSL in its 2012 February Report states the reasons for credit ceiling as firstly to curtail the import related credit thus reducing the trade deficit and the current A/C deficit, and secondly, to effectively ensure that inflation remains at the mid-single digit levels in the second half of 2012.

So, the prime objective is controlling the inflation and preserving the external reserves of the country. Each other act as a cause and effect of each other factor. As we all know, demand driven inflation is bad for an economy so long as it does not contribute to increase the output of the economy, but not so if there is an increase in the production/output levels or a corresponding contribution is made to expand the economy. If that argument was wrong world over all economies would strive to have negative inflation as was once thought in the history, but discarded after that it was proved to be ineffective.

CBSL annual reports reveal that loans1 have been disbursed to the value of Rs. 1,391.6 b in 2009, Rs. 1,799.4 b in 2010 and Rs. 2,414 b in 2011. With the restricted growth level of 18%, the total loan portfolio of the banking sector will reach little above Rs. 2,848.6 b by end 2012. This includes the loans granted by licensed non-bank financial institutions. Even though, so far, three banks would be able to have a loan growth of 23%, it may not have a significant impact on the total loan portfolio of the banking sector2.

Loan profile

However, it is worthy to analyse the loan profile of the country in line with the development goals of the economy. As identified, the main drivers of the Sri Lankan economy are; the tourism sector and the agriculture sector, mainly because of the importance of having food safety to face any shortage in the future.

Figure 1 above depicts the sector-wise distribution of loans of the commercial banks during the years 2010, 2011 and estimated amount for 2012 at the 18% growth. The loan classification has been changed in 2010 hence direct comparison of figures prior to 2010 may distort the analysis. However, certain classifications such as tourism, trading, financial, agriculture can be directly compared and the distribution pattern is depicted in Figure 2.

As is demonstrated clearly, the tourism, housing and agriculture sectors traditionally have attracted much lower quantum of loans while loans on consumption has been the highest followed by the industrial sector.

Though the limit on credit growth is on the overall credit level, in practicality banks will continue to pursue on their own speciality areas in granting loans resulting to have a similar sector-wise distribution to that of previous years among various sectors. The tendency in a volatile situation as that of present, banks would prefer short-term consumer/trade loans at higher margins to the real developmental oriented long-term loans, and that will finally fuel the overall expenditure on inflation lead consumption.

Further, along with the targeted 18% growth, the much talked about dependent tourism sector, in spite of the necessity of having approximately 42,000 rooms will attract only Rs. 50 b by end of 2012. More surprising, Sri Lanka being a country having in abundance natural beauty, favourable weather conditions, etc., the amount that the tourism sector received cumulatively during the entire period of 12 years from 2001 to 2012 do not exceed Rs. 266 b, much lesser than the inflationary ‘consumption’ would get in 2012 alone. The loan allocation for consumption purpose for the year 2012 would be approximately Rs. 680 b as against a total of Rs. 266 b for tourism for 12-year period ending 2012.

Examine the loan allocation for the much-wanted housing sector over the period and that for the year 2012. The policymakers are well aware of the shortage of housing in Sri Lanka. Based on the available data, the shortage in only 16 districts excluding that of Gampaha District is approximately 250,000 units. At a reasonable cost of Rs. 2 m per house, the requirement is over Rs. 500 b and the loan allocation is only Rs. 187 b. As is depicted on the Figure 1, housing attracts just little above the tourism sector in each year under consideration. It is so, even over the 12-year period since 2001.

Moreover, the loan allocation combined for tourism, housing and agriculture sectors for 2012 is to be much lower than that for the consumption alone for 2012. In total, while Rs. 680.4 b will be disbursed for consumption alone, the three sectors; namely

No data available for other districts and the latest available is for year 2009

As per the web site of the Department of Census and Statistics tourism, housing and agriculture cumulatively will get only Rs. 554.5 b by the end of year 2012. Refer Figure 3.

Thus, imposition of a flat credit ceiling across the board will exactly harm the very objectives of curtailing inflation and preserving the foreign reserves. The result of this indiscriminate credit ceiling will in fact further support higher inflation and wider BOP gap as there is going to be an imbalanced or disproportionate money supply to different sectors of the economy leading for a higher demand for consumption with no corresponding improvement in the output level. By the end of year 2012, the consumption sector will end up utilising over 123% of the loans that are to be allocated among these three vital sectors.

Impact on the banking sector

The banking sector of the country accounts for more than 90% of the total deposits, despite having 24 licensed banks and approximately 53 odd deposit taking financial institutions. See Figure 4. Probably the rationale of not imposing a credit ceiling for these institutions may be on the misconception of, ‘that even if all the deposits were to be released as loans the impact that it can have on the said objectives is limited’.

Well, maybe so only on the surface. The in-depth damage that this restriction imposes on the banking sector is long lasting and very costly and detrimental in the long run as they are faced with a serious problem of retention of long standing customers.

Restrictions on the credit growth only of the banking sector indirectly affects the savings level of the country as the banking sector is not in a position to deploy the funds so mobilised. However, as there is no restriction on the LFC sector of the economy in granting credit facilities, the borrowers shift the demand for loans to the LFC sector whose lending rates, other charges are generally much higher than that of the banking sector, and the current restrictions on the banking sector has offered them with an opportunity to charge an added premium.

In order to service the demand, the LFCs have to offer higher rates for depositors. Both these activities fuel the rate hike despite the very objective of controlling the inflation by imposing a credit growth. As a result, the banking sector is faced with a situation of losing its loyal customer base to small scale LFCs and in order to retain them, fuelling the inflation further, the Banks too are compelled to offer negotiable rates on various grounds for selected few or for some who are smart enough to argue or reason out with bankers.

This has created a platform for few depositors who are able to demand or shout to get a higher rate for their deposits leaving the oblivion lot in the dark. How ethical is this differentiation should be a matter of concern for the regulator.

On the other hand, the preference of the non-bank sector is for short-term credit; mostly confined to pawning, leasing, hire-purchase. There would be hardly much facilities for projects or for purposes that really have an impact on the long-term economic development of the country. Most of the facilities help increase the demand for consumables and so is the inflation.

Examine the credit growth of the economy

If the credit growth of an economy has a negative impact to the foreign reserves and to the inflation, it is interesting to examine the impact that would have made by the credit growth recorded as declared by the CBSL annual report which is reproduced here in a graphical form. The growth in total credit extended to the Government, public corporations and to the private sector is tabulated in table 02.

As disclosed by the CBSL annual report, total loans granted to the public corporations have increased by over 37% in 2012 compared to 2011. The total loans granted to the Government have increased by 24% in 2012. Jointly these two have had a growth of 61% as against an increase of 36% on loans granted to the private sector. Probably the biggest takers could be the CEB and the CPC. The contribution to inflation by these two sectors; and more specifically the public corporations; one has to evaluate under a special study.

It is further interesting to note the sources of these funding and its impact towards inflation. The CBSL annual report further discloses the following facts.

The Central Bank of Sri Lanka has lent Rs. 262.7 b to the Government in 2011. To our knowledge, the only way Central Bank can lend is by way of printing money and that directly subscribes for inflation of an economy. Further, the Commercial Banks collectively have filled the budgetary gap by Rs. 571 b while the LSBs – very few players, have contributed Rs. 310 b in 2011 – most of it for inflationary expenses.

The credit extended by the CBSL to the Government has increased by 242% in from 2010 to 2011. The increase compared to the amount granted by CBSL in 2009 to 2011 is 141%. Understandably and justifiably, the government had to meet many a requirement compared to the year 2009. As argued at the beginning of this document, 2009 onwards the country is treading on an entirely a different socio economic path. However, the fact remains, any money printing by CBSL has its part of contribution to the inflation.

Nevertheless, for an economy to run, more of on an accelerated developmental path sufficient money supply is vital so is vital to have a well-guarded flow of money supply. Not too much - not too low. Curtailing that flow equally across the board by one stroke of a pen does not augur well for an economy, especially for that of ours at this time of the history.

The gates should be closed only where it is wide opened and invites too much inflation and eats up foreign reserves. It necessarily needs to be kept wide open for elements that contribute future prosperity. So, the need of the hour is a well thought distribution of the required quantum of money supply among the vital sectors of the economy. Not a scheme that gives an outcome shown in Figures 1 and 3 viz. the largest amount for consumption and the lowest to economically important sectors such as tourism, housing, agriculture, etc.

A timely topic for the bankers to discuss – sustainability in volatility!



Footnotes:

1 Presume this includes the loans granted by licensed specialised banks

2 Excludes the loans granted by co-operative societies as the amounts are insignificant



(The writer is an MBA holder with over 15 years of experience in the banking sector and five years in the field of fund management.)