Banks reopen lending spigots as credit to private sector picks up in June after 12 months

• Banks on a net basis provided Rs.73.8bn in fresh credit to private businesses and individuals in June
• Indicate signs of economic recovery after a severe and prolonged credit contraction during the last 1.5 years
• Private sector credit a crucial economic indicator that offers insights into the future trajectory of the economy

Breaking one of the most severe and prolonged credit contractions in the Sri Lankan economy, banks witnessed an expansion in credit extended to private borrowers in June, indicating signs of economic recovery from the deep recession the country has been in during the last one and half years.

Central Bank data showed that banks on a net basis provided Rs.73.8 billion in fresh credit to private businesses and individuals in June, reversing from Rs.88.8 billion contraction in May, which took the cumulative contraction in credit to Rs.800 billion in the 12 months through May.
Private sector credit serves as a vital indicator of economic well-being and provides valuable insights into the future trajectory of the economy. 

As projections indicate that the economy hit its lowest point in June and is poised for expansion in the second half, monitoring private sector credit becomes even more critical to assess the overall economic direction.
The unexpected upturn in June’s credit activity came as a pleasant surprise to the market, specially considering the substantial jump from a contraction to an expansion. Many had anticipated a more gradual recovery in private credit.

The June credit expansion also coincided with the beginning of the monetary easing cycle after nearly two years of ultra tight monetary policy pursued by the Central Bank to combat runaway inflation, which gripped the economy last year through the second quarter of this year. 

The faster than expected disinflation cycle gave the Monetary Board more space to accelerate its monetary easing action as it delivered back-to-back rate cuts in June and July amounting to a cumulative 450 basis points.
Analysts expect another cut in rates at the upcoming policy meeting later this month, which will further put pressure on banks to reduce lending rates and thereby accelerate the flow of credit to the real economy. 
Banks have shown stubborn rigidity in cutting lending rates but were quick to cut the deposit, rates which earned the ire of both borrowers and the regulator alike. 

The Central Bank has already warned banks that it would not hesitate to take administrative measures to bring the rates down from their still elevated levels if banks either fail or delay the passthrough of the benefit of policy rate cuts to consumers.
Interest rates for SMEs continue to remain at around 20 percent, which is an alarming level for any legitimate business. Running a business with such high borrowing costs becomes particularly challenging in a country where the overall doing business conditions remain depressed due to red tape, corruption etc.

The current situation in Sri Lanka poses significant obstacles to genuine entrepreneurship and enterprise building. The prevailing conditions make it difficult for small and medium-sized businesses to thrive, while larger corporations gain a competitive advantage and consolidate their positions, potentially leading to virtual monopolistic conditions.
As a result, these big corporations may have greater control over product prices and labour costs, further exacerbating economic inequality and limiting opportunities for smaller businesses and entrepreneurs to flourish.