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Wednesday, 8 November 2017 00:00 - - {{hitsCtrl.values.hits}}
By Uditha Jayasinghe
Days ahead of Budget 2018, the Central Bank yesterday kept rates unchanged citing slowing credit growth, strengthened global activity and growth recovery in the second half but acknowledged that significant investment pickup had failed to materialise.
Central Bank Governor Dr. Indrajit Coomaraswamy, speaking to reporters, conceded that despite credit growth slowing to 17.5% in September from 18% in August, credit flow to significant domestic investment had not appeared.
In absolute terms, the increase in credit to the private sector in September 2017 was Rs. 50.1 billion, while the cumulative expansion in credit during the first nine months of 2017 was Rs. 454.7 billion compared to Rs. 515.8 billion in the corresponding period of 2016.
“Credit growth peaked at about 28% at the middle of last year and since then it has been coming down. We would like to get it down to 15%-16% by the end of the year. Part of why it is not feeding into growth is because there is a fair amount of it going to the Government as net credit. Despite credit to the private sector we are not seeing investment because even though consumption has come down there hasn’t been the pickup in investment one would have hoped for. That is really the challenge,” he said.
Net Credit to Government (NCG) from the banking system declined by Rs. 14 billion in September 2017. However, so far in 2017 NCG from the banking system has increased by Rs. 251.4 billion. In 2016, it was Rs. 212.6 billion. Credit to public corporations contracted by Rs. 5.4 billion in September 2017. On a cumulative basis, credit to public corporations increased by Rs. 2.4 billion during the first nine months of 2017 compared to the contraction of Rs. 27.9 billion during 2016, Central Bank data showed.
“Going forward we hope for credit growth to come down a little bit more and the composition of that credit to change and, as the macroeconomic conditions become more stable, investment to improve. I think if the Budget is well aligned with the Government’s V2025 framework, which would then be an indicator that there is likely to be predictability and consistency in policymaking, then I think you would see sentiment change, investment pick up and credit get channeled to the productive segments of the economy,” he added.
The relationship between credit and growth is weakening in other countries as well, he noted, and could be due to increased complexity in the international financial sector. In the past as much as 30%-40% of credit flowed to consumption and the construction sector, officials noted, but even though the Central Bank is attempting to change flows and prevent bubbles from forming in different sectors, and consumption as well as construction is reducing, the percentage of credit to them has remained stubbornly high.
Construction in particular has set itself as a challenge because as a non-tradable sector it does not attract much foreign exchange. However, the Central Bank is upbeat of its prospects and will focus on supporting it to grow sustainably.
“It’s important to realise that construction is a segmented market. Demand exists in the affordable and mid-market segments and real estate companies are also beginning to move from the high-end to the mid-market side to improve supply. Where we had some questions was the high end of the market where there is a lot of inventory coming on stream, next year and the year after, as to whether there is a bubble.”
“When you look at the credit numbers and the exposure of the banking sector to the real estate sector, for the moment there doesn’t seem to be a problem but we are considering macroprudential measures, not necessarily because we think there is a bubble, but we are wondering whether it is necessary to put in place measures to have sustained growth in this sector and there are things like loans to value, debt servicing and other various ratios one can apply, which other countries have done, not because they think there is overheating but simply to ensure growth is sustained.”
Even though a considerable amount of money is still being funneled into the sector there is not unsustainable exposure of the banking sector to the high-end real estate sector at the moment, he said. Banks themselves are also working to protect themselves, without intervention from the Central Bank.
As a rate increase has been signaled by the US Federal Reserve for several months it has been “baked in” to the Central Bank’s projections, the Governor said, noting that they do not expect significant disruptions to the market or immediate impact for Sri Lanka. He also expressed confidence that the new head of the US Fed has similar ideals as his predecessor and therefore would work for a smooth and gradual transition of the rate cycle.
“This is uncharted territory, particularly since unwinding the Fed balance sheets will happen side by side with a normalisation of interest rates. One does not know what impact it will have in terms of asset markets and currency markets but if it is very gradual and the peak is not too high then hopefully there will be a soft landing,” he said.
For Sri Lanka, it is unlikely the December rate hike will have an impact but additional increases next year, possibly three, means the Central Bank has to ensure that it borrows judiciously from international capital markets. Since Sri Lanka has both a budget deficit and a trade deficit it has had to face high premiums on borrowing costs but if the fiscal consolidation efforts continue then the premium will come down and mitigate the increase in the Fed rate, the Governor opined, which would contain any adverse results from an increase in international interest rates.
Despite the Central Bank anticipating two peaks in inflation, one around March and the second one about October, Dr. Coomaraswamy acknowledged headline inflation is higher than what was projected. Nonetheless, he argued that the Central Bank could only exert influence over core inflation, which at mid-single digits was within target, pointing out that headline inflation was high because of weather-related supply-side issues and tax adjustments such as VAT.
“Up to now the increase in inflation is due to reasons which the Central Bank has no influence over. To change monetary policy at this point to address that problem would not be appropriate,” he said but warned that if high inflation persisted then it could spill over into demand for higher wages and other pressures that could put fiscal consolidation at risk.
