ECONOMYNEXT – Sri Lanka’s loans to private businesses surged to 173 billion rupees in March, up from 105.5 billion rupees in February, while government credit also expanded, official data show.
In Sri Lanka private credit usually expands in March ahead of the April New Year.
Sri Lanka’s private credit has expanded by 1,036 million rupees in the 12 months to March.
In the 12 months to March 2024, private credit expanded by only 240 billion rupees, allowing foreign debt to be repaid by both the government and the central bank, and reserves lost during a period when rates were cut, have to be re-built.
When a flexible inflation central bank cuts rates with inflationary open market operations and triggers a foreign exchange crisis undermining confidence in its note-issue, economic activity has to be crushed to restore confidence in the currency.
The fall in demand from a collapsed currency which deals a blow to household budgets then decimates consumption and stops any requirement for expansion by businesses. Cost of building a house also become prohibitively expensive compared to wages.
Instead, the focus is to repay debt and survive in the stabilization crisis.
As prices stabilize and incomes recover, and consumption recovers about 12 to 18 months later, businesses think of expanding, buying new equipment or vehicles, or constructing new buildings which have a planning and approval horizon.
Since the end of a civil war, Sri Lanka’s central bank has cut rates with printed money or inflationary open market operations around the time private recoveries claiming inflation was low in the previous 12 months there was ‘room’ to cut rates, analysts have pointed out.
Accommodative Monetary Policy
If rates are cut with inflationary open market operations (so-called accommodative monetary policy) and credit growth is strong, a fresh run is triggered on the foreign assets of a reserve collecting central bank (a currency crisis) and resulting in a rise in interest rates in the stabilization crisis that follows.
A modern central bank in a monetarily unstable country may cut rates with printed money either to push up food and other prices to reach an inflation target or to target a mid-corridor or ‘single’ policy in the belief reserve money expansion can permanently reduce interest rates.
Classical economists from Adam Smith to David Ricardo however have pointed out that a country’s interest rates are a function of capital and not the circulating medium (reserve money), unlike the doctrine propagated by John Law.
“It can, I think, be made manifest, that the rate of interest is not regulated by the abundance or scarcity of money, but by the abundance or scarcity of that part of capital, not consisting of money,” explained Ricardo.
In recent weeks the signalled ‘single’ policy rate has been slightly the actual floor rate, allowing excess liquidity to build up from dollar purchases. Whether is sufficient to meet reserve targets and repay foreign debt falling due is not clear given recent foreign reserve trends.
Sri Lanka ‘single’ policy rate signals interbank rates to stay up
Sri Lanka foreign reserves in April 2025 drop below October level: analysis
Credit to Government
Sri Lanka bank credit to the government was only 29.4 billion rupees in March, up from a contraction of 36.7 billion rupees in February.
Sri Lanka’s government has raised taxes and up to 2024 also kept a check on spending. However subsidies to farmers are increasing and state salaries are being hiked, which was expected after their real salaries were slashed in the currency collapse.
Rice farmers who are growing vegetables are being given fertilizer subsidies from this year, as freelancers who are exporting services are being taxed under the IMF program.
In another more worrying trend, the state is again being expanded with unemployable graduates being hired into the public sector, a strategy followed in the Rajapaska regime. The defunct Co-operative Wholesale Establishment is also being revived.
Under so-called revenue-based consolidation backed by the International Monetary Fund since around 2015 there is no check on spending unlike classical fiscal consolidation, leading to no lasting correction in budget deficits.
Credit to the government from banks may also fall if interest rates are low and banks divert money to private credit. In the past the central bank printed money to push down gilt yields when banks focused on higher yielding private credit.
In August 2024, bank credit to the government fell 42.6 billion rupees and private credit expanded 135 billion rupees.
In September bank credit to the government was only 8.68 billion rupees and private credit was 88.9 billion rupees.
As interbank rates went up the central bank printed large volumes of money to maintain its mid-corridor rate.
With the government deficit falling, interest rates can remain low if the macroeconomists do not reject economics and try to undermine the workings of the interbank markets and destroy the currency and real financial capital, analysts have said.
Liquidity
Excess liquidity in the banking system went up in May to close to 200 billion rupees, but mostly from dollar purchases.
The central bank had also borrowed dollars from swaps, instead of buying them outright, a practice which critics say has fueled crises and default in the past. There have been calls for parliament to outlaw the practice.
In March central bank credit to the government expanded by 66.1 billion rupees for reasons that are not immediately clear from published data as there was no overt money printing.
Central bank credit numbers have sometimes changed due to valuation changes on its bond portfolio. (Colombo/May12/2025)
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