Interest rates dilemma

THE Monetary Board early this week took a firm decision that interest rates must come down further. This message was conveyed by cutting policy rates by 25 and 50 basis points. As reported in yesterday’s issue of the Daily FT, the move by the Monetary Board surprised most analysts in the financial services industry.

The Central Bank of Sri Lanka also singled itself out from most of its other global colleagues by the move.

In the next few days or at least till the February Monetary Policy Review, the decision made this week would be highly debated in financial circles.

In short, the cut in policy rates exposes a few home truths, though some – in the Central Bank as well as the banking community in general – may not like to admit it openly.

Despite the Monetary Board cutting policy rates by 350 basis points since February 2009, the desired speedier downward revision in lending rates by commercial banks hasn’t happened. Not only on Monday but even before the presentation of Budget 2011, the Finance Ministry has been vocal and insistent that interest rates should and could come down further.

There is no denial of the fact that in comparison to 2009, interest rates have come down. The Central Bank puts it at 2%. A quick glance at listed company profit and loss accounts will show how much most companies have enjoyed the lower cost of finance, which has helped their bottom line.

The Average Weighted Prime Lending Rate in December was 9.27%, with State banks’ rate ranging between 10.75% and 8.65% and private sector banks’ figure ranging between 8.25% and 11.29%. However, it is only a handful of enterprises that can enjoy this luxurious rate. Given their cash rich balance sheets, these companies can meet their expansions via internal funds. The rest of the private sector has been complaining that borrowing rates remain relatively high. The same goes for rates on leasing, which is the most popular among small and medium enterprises.

So there is a credible case for a much lower scenario for interest rates but commercial banks are apparently refusing to stoop down to the level which the Government wants them to. This is because the banking industry is of the view that further downward revision is unwarranted. For the most part of last year, some bankers have been maintaining that interest rate levels were satisfactory in relation to the macroeconomic fundamentals.

With greater upward pressure on consumer prices in recent months as well and bankers’ own forecast for inflation for 2011, the industry sees little sense in interest rates declining. With 2011 also being a mini election year, some doubt has been cast on the success of the Government’s fiscal consolidation. However, the Government has reaffirmed that key targets will be met and the macroeconomic scenario will further improve. The high growth in private sector credit (18% in October and 23% in November) despite the low base or negative growth in 2009 is encouraging, but the Government is keen to fuel further private sector borrowing for new investments.

Banks, on the other hand, opine private sector appetite for credit is still low, which implies that the overall confidence level of the business community hasn’t improved considerably post-war. Here the banks need to be the creator of opportunities proactively, rather than waiting till customers come to them.

There are also reports that having learned to manage within means during crisis times, a fair number of companies are improving their businesses without incurring extra cost. This in effect means better productivity within the private sector, which is encouraging, though there is much room for improvement.

The Government also feels improved efficiency is critical for banks as well and this is a key factor if the Central Bank-estimated interest spread of 4.5% and the overall intermediation cost is to be brought down further.

We strongly feel there is an urgent need to make a sincere assessment of the overall status quo of the economy, its growth prospects as well as the banking sector’s commitment. Both sides need to realistically walk the talk, be it separately or collectively, rather than one side being too ambitious and the other more passive. Failure will only prolong the much neededfaster, truer and highly-inclusive post-war growth in Sri Lanka.