Private credit continues to fall as economy in serious decline

• Credit to private sector contracts fell Rs.41bn in July, after falling by a similar amount in June 
• Sky-high interest rates adopted to fight inflation and tightening of credit standards by banks among key reasons
• Sri Lanka’s economy projected to shrink by 8% in 2022

Credit to the private sector, a key barometer of economic dynamism, has continued to shrink for the third consecutive month in July in response to the sky-high interest rates adopted to fight inflation and tightening credit standards by the banking and financial sector.
According to the latest data, credit to businesses and private individuals from licensed commercial banks fell Rs.41.0 billion, on par with the June number, after the policy jumbo rate hike in April pushed prospective borrowers into sidelines and banks to become more cautious against fresh lending after the economy crashed in March. 

While June quarter earnings reports of the banking sector offered a preview of what could come in the back half of the year with muted growths in their portfolios, July data reinforced that banks could see smaller balance sheets by the end of the current financial year from where they started the year as they have virtually closed their lending spigots.
Banks are fast re-pricing their loans to fatten their loan margins in a desperate bid to maintain their previous year bottomlines at a minimum, although the higher provisions are making it harder.  

Banks and the broader financial sector benefited from the latter half of 2020 through the entirety of 2021 from the record low interest rates, which came as part of the unprecedented level of monetary stimulus unleashed by the Central Bank to prop up the economy which was badly beset by the pandemic-related lockdowns. 
But soon the global demand surpassed the supply which was exacerbated by the Ukrainian war in February 2022 sending global commodities prices to decades high, prompting the central banks around the world to switch gears and tighten their policies to rein in inflation.

In Sri Lanka, the acute dollar shortage and the resulting rupee float made the inflation fight even harder as prices rose by many multiples from the impact coming from a weaker rupee, years-long overdue administrative price adjustments coming all at once to fix the ailing budget and higher prices from the commodities shortages. As the supply doesn’t have a quick fix, the Central Bank made its policy bone crushingly tight to stem money flows into businesses and people by way of loans so that demand is brought in balance with supply and the availability of dollars, as seen from the most recent external trade data. 

Sri Lanka’s economy is projected to shrink by 8 percent in 2022 after anemic growth reported since 2016 onwards. The attempt made to recharge growth from 2020 onwards through fiscal and monetary stimulus was largely beset by the pandemic which gave rise to inflation and drought in foreign currency inflows, causing the economy to collapse.