Private sector credit continues to decelerate as financial conditions tighten

The credit to the private sector continued to contract for the second consecutive month, as sky-high interest rates pushed the potential borrowers to the sidelines while the banks effectively closed their lending spigots, except for their most prime clients and those who show some resilience to the worst economic crisis in Sri Lanka’s post-independence history. 

Credit to private borrowers—both businesses and individuals—fell by Rs.40.6 billion in June but the contraction was less pronounced at Rs.14.3 billion when adjusted for the impact coming from the steeper fall in the rupee against the dollar. This is compared with the Rs.47.3 billion decline in the outstanding credit to the private sector in May adjusted for the translation impact. 

The contraction in the private sector credit comes as no surprise, as this is precisely what the Monetary Board aimed at doing with its aggressive monetary tightening that began in April to fight runaway inflation. 

With the June data on private credit, it has now become clear that the policies undertaken by the Central Bank are working towards its desired goals of slowing money supply, easing imports and thereby enabling the inflation to turn a corner, which ended up just shy of 70 percent in July, nationally. 

Announcing the latest monetary policy stance a fortnight ago, where the benchmark rates were kept unchanged, the Central Bank assumed rather a conciliatory tone on inflation, which was earlier expected to peak at 70 percent, as its projections suggest a deceleration in inflation in the coming months. 

However, the Central Bank’s battle against inflation is coming at the cost of a larger than expected economic contraction, which could result in large-scale job losses, business shutdowns, loss of livelihoods, hunger and poverty and loss of at least decades worth of economic opportunities for a large swath of the population, who are now seeking greener pastures elsewhere in the world.

As the economy loses its top talent and the people in their prime working age leave the country in droves, Sri Lanka could face its next big challenge of rebooting its growth when it starts to recover from the current economic crisis, potentially after a much-expected bailout deal with the International Monetary Fund.

However, with inflation at where it is now, nothing or no-one can have any hope of economic prosperity in Sri Lanka, as one’s earnings have become nothing in real terms in comparison to the multifold price increases in consumer prices. 

Meanwhile, the net credit to the government in June increased substantially by Rs.178.2 billion while outstanding credit to public corporations declined by Rs.21.0 billion in the same month. The Central Bank recently said with the current fiscal tightening and the reforms to the state-owned enterprises, such as cost-reflective pricing, could contain future monetary financing of the budget deficit. 

The signs of this can already be seen in August, where the Central Bank holdings of the government securities stock had risen by only little compared to billions of rupees of months-long printed money provided to the government, partly stoking the current bout of inflation and the balance of payment troubles.