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Interest rates rising as state demand for credit increases
Govts can’t understand private sector

A top business executive says successive governments have failed to understand the importance of the long term capital needs of the private sector while crowding-out the private sector from domestic credit to finance budget deficits through short term borrowings from captive sources while fiscal indiscipline could bring back high interest rates once again.

Market interest rates are much lower than they were a year ago, but private sector credit growth is still sluggish. Dealers said this was because most investors were adopting a wait-and-see attitude until the general election next month. They also said not many creditworthy borrowers were approaching banks either.

But many businesses, especially the SME sector, complain that accessing bank credit lines are extremely difficult. Banks are not delivering on their advertised promises either; claims that different banks make that they would play a greater role in Sri Lanka’s post-war economic development.

Meanwhile, interbank rates and benchmark Treasury bill rates have been moving upwards, albeit very slowly, as government demand for more credit from the banking sector is on the increase. Dealers said some state agents were even borrowing at rates higher than the market rates.

The Association of Chartered Certified Accountants (ACCA) and RAM Ratings organised a business forum last Friday on developing Sri Lanka’s bond market.

The issue of low interest rates, bank lending and crowding out the private sector’s need for credit by the government, which is constantly tapping in to captive sources, such as the EPF, for short term borrowings to finance deficits, came up for discussion at this forum.

"The state sector is crowing out the private sector’s need for long term funds. Unfortunately all governments do not realise the value of long term capital to the private sector," Ranjit Fernando, Chairman, United Motors, told the forum.

"The problem is that governments do not realise that the private sector needs access to long term funds. Instead, they tap into captive sources for short term financing and crowd out the private sector in the process," he said.

Fernando said fiscal indiscipline was the main reason for this, with all governments working on deficit budgets. Borrowing from the domestic sector to finance deficits have not only taken away funds that could have gone to the private sector for much productive use, but has fuelled inflation which in tern raises interest rates as the Central Bank steps in to contain inflation.

Sri Lanka has a history of high inflation, called chronic inflation caused by structural fiscal problems. High global commodity prices in the recent past have made matters worse. In June 2008, inflation peaked at 28.2 percent.

High inflation also means the private sector makes negative returns on their investments while production costs and labour costs increase adding to pressure on margins. Individuals make negative real returns on their deposits as interest rates are lower than the rate of inflation.

Since mid-2009, however, inflation has been brought down to low levels and market interest rates have also adjusted downwards but banks were still not comfortable lending.

Towards the end of 2009, banks preferred to lock their funds in government securities rather than lend and this prompted a presidential directive to state-owned banks to lower rates to as mush as 8 percent per annum on credit to selected sectors, particularly to SMEs.

Three months into 2010, dealers say private sector lending is probably beginning to pick up but banks still prefer government securities.

Fernando said the private sector was concerned that banks were not lending as much as they would like, but he also expressed a concern held my many in the private sector, including the banks themselves.

"Today, interest rates are down but for how long can this be sustained with government fiscal indiscipline?" he asked.

Central Bank Governor Ajith Nivard Cabraal said last January that a lot of hard work went into containing inflation and bringing in an environment of low inflation. He warned the government that reckless government spending could threaten to undo all this.

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