Interest rates and growth

The Government has announced plans to reduce interest rates in an effort to boost growth by allowing businesses to access capital more easily. The logic of this decision, which has been backed by the Central Bank, is that the interest rates implemented by the banks are higher than the policy rates prescribed by the monetary authority. This could lead to missing the target for private credit growth. 

With elections around the corner, the Government is understandably keen to shed its image of imposing high interest rates and present a more pro-business image. While reduced interest rates would be positive for the economy, the link between capital that can be obtained at somewhat lower levels and growth is a tenuous one, with most companies and investors taking a range of points into consideration before making a commitment to expand. 

Central Bank Governor Dr. Indrajit Coomaraswamy has noted that Sri Lanka’s private credit fell by Rs. 4.3 billion in January and grew by Rs. 7.6 billion in February. The Governor has said if the 13.5% annual private credit growth target for 2019 is to be achieved, credit growth has to average Rs.75 billion per month for the rest of the year.

Experience shows that no country in the world has been able to create opportunities for its population entirely within its own geographic boundaries. To succeed in this open environment, Sri Lanka will need to improve its skills base, better understand supply and demand chains as well as produce higher quality goods and services

Sri Lanka attracts less foreign investment than other comparable economies - and only a small proportion of these investments generate diversified exports or jobs. Enhancing the Board of Investment’s capacity to attract and retain foreign investment, creating a one-stop shop that streamlines all foreign investment-related approvals in Sri Lanka, will be key to attracting more businesses. These investments would also have to be credible.  

A significant part of this effort will also include improving trade competitiveness by reducing the time and cost required to fulfil regulatory processes to import and export. These policies have been tied to improving Sri Lanka’s ranking in the Ease of Doing Business rankings. Access to capital, while important, does not necessarily improve access to markets, which is a significant challenge for many businesses looking to expand.  

For economic growth that will be genuinely felt by the people, the Government also has to target policies that will assist the underproductive agriculture sector, which employs over 27% of the population and tends to be a strong vote bank as well. Pushing down interest rates will also have limited impact because they usually spillover into imports, which the economy with its low reserves cannot support. This means the Central Bank will likely continue implementing macro prudential measures to guard against increased vehicle imports and construction. 

This, together with the overall political uncertainty, is unlikely to motivate many companies to avail themselves to lower interest credit in the short term. A large number of older people also rely on interest rates to get an adequate income in their retirement and seeing interest rates reduce could also result in a backlash from pensioners. These are just a few of the reasons as to why interest rates have to be treated with care and a holistic approach is needed for growth.