Central Bank likely to lean against what govt. wants to lean on i.e. low interest rates

The Central Bank may have maintained its current monetary policy stance last week but the Monetary Board is likely to tread on a rocky road for the next few months as it will face the dual challenge of avoiding any more outflows from the government securities market and lean against any fiscal excesses by a government facing impending elections. 

The private credit growth, though moderated on a year-on-year (YoY) basis, has accelerated its pace in June and the government is seen gradually ramping up its populist spending on various campaigns targeting the elections late next year and beyond.

The banks have loaned a significant Rs.83 billion in new loans to the private citizens and companies on consumption and investments, an increase of 14.9 percent YoY, moderating from 15.1 percent in May. However, this marks a jump from Rs.22.3 billion in April and Rs.28.8 billion in May. 

The Central Bank hopes to end the year with only Rs.650 billion in total private sector credit with a YoY increase of not more than 13 to 14 percent. 

However, the fact that the private sector credit has already surpassed Rs.408 billion during the first six months might prompt the Monetary Board to contemplate on its future course of action to tame any surges. 

The bank credit growth in the second half of a year is typically faster than the first half. 

Most likely, on the Central Bank advice, the Finance Ministry last week raised the taxes on small cars to prune the import frenzy of such vehicles—a major cause for the widening of the trade gap during the first five months of the year. 

As a result, the demand for vehicle leasing could become weak but the banks remain capital rich to unload on many other products from housing loans to consumer loans to SME and corporate facilities as they remain hungry for growth during the second half after seeing their profits being eroded during the first half, due to the hefty bad loan provisions. 

Meanwhile, the Central Bank being true to its independence and commitments to the International Monetary Fund will have to lean against any fiscal excesses by the government. 

This means a higher borrowing cost for individuals and corporates, which could further thrash the growth prospects for the already wobbling economy—a nightmare situation for any government seeking re-election.  

If the Central Bank allows the fiscal excesses by the government, all its efforts during the last two years to build strong macro-economic fundamentals will go down the drain. Besides, this is not something that a sane Central Bank could allow when the country faces US $ 15 billion debt repayments during the next five years. 

Also, the Central Bank will have to deal with the resultant overheating of the economy and the inflation created by a higher-spending election-oriented government. 

Perhaps the strongest push for higher rates or monetary tightening is coming from the moves by the United States Federal Reserve, which is set to raise its short-term interest rates twice this year and thrice in 2019. 

If the Central Bank maintains its current policy stance, it will risk losing its remaining foreign holdings in the government securities. 

Sri Lanka lost foreign investments worth US $ 229 million in government securities up to August 1 from the beginning of 2018. 

Hence, economists believe external factors are more likely to influence Sri Lanka’s future monetary policy than domestic factors.