ECONOMYNEXT- Sri Lanka’s private credit expanded 789.6 billion rupees in 2024, compared to a 47.7 billion rupee contraction in 2023 in a stabilization crisis, with a strong year end surge, official data shows.
Sri Lanka has steep fluctuations in private credit and economy output volatility as rates are cut with inflationary open market operations triggering external crises, followed by steep rate hikes to kill private credit and restore lost confidence in the rupee.
The 2024 number is just short of 810 billion rupees recorded in the crisis year of 2021, where large volumes of money was printed through direct and open market operations to keep policy rates down triggering parallel exchange rate, or loss of confidence in the rupee.
At the time the rupee was around 200 to the US dollar and it is now 300, indicating that the cost of an investment would now be at least 50 percent higher, not counting inflation created by the Federal Reserve in building materials.
Out of the 789 billion rupees of annual private credit, 583 billion rupees came in the last five month of the year.
In December private credit was 193 billion rupees, up from 71 billion rupees in October and 19 billion rupees in November.
In Sri Lanka, after inflationary rate cuts (go policies) trigger a currency crisis, it usually takes about 12 to 18 months for private credit to recover as prices of building materials stabilize and domestic demand resumes after salaries gradually recover, based on past data.
Private credit has to be crushed in part to finance the government deficit which soars as the stabilization crisis starts, which require steeply higher interest rates and taxes have to be hiked ad hoc to stop the currency crises from rate cuts.
Businesses do not make plans to expand, until demand or sales start to recover. They instead focus on repaying debt. Companies that survive the ‘stop’ policies can then be leaner, and less leveraged.
Concerns were raised around October about inflationary open market operations resuming injecting large volumes of excess liquidity to banks, which then end up in the forex market after several rounds of credit.
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Analysts have blamed the problem on operating a so-called abundant (rupee) reserve system (ABS) of targeting mid-corridor or single rate which amounts to a ‘floor’ rate abandoning a scarce reserve regime (SRS) linked to ceiling rate injections, that is required to keep the exchange rate stable and build foreign reserves.
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However the central bank mopped up large volumes of liquidity from dollar inflows overall in 2024, re-building foreign reserves, until its Treasury bill holdings ran out. The interest on its government bond portfolio is also deflationary.
Scarce reserve systems only provide printed money for clearing purposes for a day or two, while a single policy rate, which is de facto is a ‘floor’ rate, provides cash for banks to lend without deposits.
Weakening exchange rates (flexible exchange rate) can also lead to early covering of import credits, further worsening the cycle and exporters may also reduce conversions of dollars and rely on credit.
The excess liquidity from inflationary open market operations have been extinguished.
Meanwhile Sri Lanka’s stock market also took off in the last three months. A central bank official told reporters that the increase in bank margin loans in December was ‘not much’. Broker credit was the purview of the Securities and Exchange Commission, it was said.
However, stock market disclosures on large acquisitions showed purchases through so-called ‘slash’ accounts.
There was also a spike in credit to the government in December to 188 billion rupees for reasons that are not immediately clear. Credit to state enterprises also rose after contracting in November. (Colombo/Feb02/2025)
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