Persistently elevated rates risk pushing highly indebted borrowers out of business

• CT CLSA anticipates rate cuts from as early as first quarter next year to ensure stability
• CB wants near term market rates to ease prior to any reduction in policy rates  
• Corporate bankruptcies could send second round ripple effects after country declared bankruptcy this year

Offering a dire warning of what could become possible from higher interest rates in an extended period, CT CLSA Securities said unless the rates start coming down at least from the first half of next year, highly leveraged companies could see debt distress, potentially threatening their solvency, adding further woes to the crisis-stricken economy. 

In a report released alongside its recent South Asia Frontier Forum, the stock brokerage joined a handful of market participants and analysts who priced in a pivot in the Central Bank monetary policy towards the first quarter of next year, reversing course from the months-long monetary tightening campaign, which took the borrowing cost to exponential levels overnight, yet ended up breaking the inflationary cycle. 

The Central Bank raised its policy rates by an unprecedented 700 basis points in April bringing the cumulative increase in key rates to 1,000 basis points within a short span of 12 months to combat inflation which got out of control from earlier this year. 

But, this sharp shift in the monetary policy pushed many borrowers into the brink, making them unable to repay the loans they took just a couple of years ago at historically low rates causing enormous stress to the banking sector asset quality. 

Under these circumstances, the CT CLSA called for a “swift” reduction in the rates to both prevent potential corporate bankruptcies and ensure the economy doesn’t damage to irreparable levels. 

“CBSL may have to act swiftly to reduce overall interest rates, to ensure economic stability given unsustainable high AWPLR as of now,” the stock broker said. The average weighted prime lending rate, which captures the average rate of all loans to prime customers of banks during the week ending last week shot up to 28.51 percent, more than tripling the 8.16 percent levels a year ago.  CT CLSA called them  alarmingly high rates,” which are seen for the first time in Sri Lanka’s history. 

“If interest rates are not reduced during 1H2023E, some high leveraged companies may face serious liquidity and going concern issues,” it cautioned. 

Sri Lankan corporates in the two years of the pandemic, during which time the borrowing rates were brought down to lowest-ever levels took on more debt to expand their operations and build more capacity only to see the economy which they were operating in is crumbling down. 

The current depressed operating conditions impacted their top and bottomlines in 2022, adversely affecting their operating cash flows while sending their debt servicing costs through the roof, causing them a double whammy and thereby creating near term 

stability concerns.  At a time when the country has gone into bankruptcy by failing to honour its debt obligations, corporate failures caused by their inability to service their loans could further compound the woes faced by the country because that will cause thousands of job losses.

The Central Bank hasn’t indicated when it would turn to cutting rates but wanted the near term market rates to come off from where they are at present. The Central Bank believes the short-term rates are excessively high compared to the policy rates which are currently at 14.5 percent 15.5 percent. 

However, the pressure is mounting on the Central Bank to ease credit conditions in order to alleviate the hardships faced by borrowers and unshackle the economy.