ICRA Lanka explains possible reasons for anaemic private credit growth

• Says companies may be trading their existing loans with new loans to take advantage of low borrowing cost

Sri Lanka’s private sector credit growth shrank three months consecutively, albeit the gap was seen narrowing each month until end-July but the rating agency ICRA Lanka offered reasons as to why the growth remained negative, although the gross loan disbursements reaching pre-pandemic highs.

Sri Lanka’s private sector credit, a gauge of the recovery in economic activities, slipped by Rs.3.6 billion in July, closing in on the gap from negative growths of Rs.54 billion in June and Rs.70 billion in May, showing a faster rebound in economic activities after the pandemic-related restrictions were eased.

ICRA Lanka, part of Moody’s Investors Service, said the companies may be refinancing their existing debt already at higher interest rates, with low interest rate loans, to take advantage of the lower borrowings costs, which could enhance earnings and bring down the overall cost of capital. 

This condition was seen from the gross bank loan disbursements, which surpassed the pre-pandemic highs in mid-July, as the banks were processing a record number of loan applications from customers. 

However, the net growth in loans remained negative due to settlements, which typically happens in a refinance, offsetting the disbursement in new loans during the period. 

When interest rates trend lower in an economy, companies tend to refinance their debt to benefit from the lower borrowing cost, as they trade in their existing loans with new loans taken at lower rates. 

This pushes the net interest margins of the banking sector lower but benefits all stakeholders, as low rates help banks to expand much faster while bringing the overall cost of capital of an economy lower, creating incentives for investments, job creation and economic output.  

Further, some of the companies may have also been able to manage liquidity without having to acquire new credit during and in the immediate aftermath of the pandemic, making no impact on private credit, ICRA Lanka said. 

Companies also instituted some tougher operational cost control strategies to bring overheads down and put on hold capital expenditure projects, to conserve cash at the height of the pandemic, expecting the worst. These proactive strategies may have helped them to manage the existing cash flows, without having to apply for additional liquidity from banks. 

According to the rating agency, there were also some companies that remained on a ‘wait-and-see’ mode in the immediate aftermath of the pandemic, before making any fresh borrowings for expansion, until they see a clearer picture about the demand recovery and the trajectory of the overall economy.

The Central Bank expects the private sector credit to grow by 4 percent in 2020, revised down from its 12 percent prior to the pandemic. 

Private sector credit growth accelerates when the recovery of an economy happens fast, as both individuals and businesses demand for more money for their consumption and investments, in an expanding economy.