Sri Lanka Govt Borrowings from Domestic Sources up by 90.7 Pct

05th October 2009, www.island.lk, By Devan Daniel

A top official of the Central Bank says inflation is forecast to increase by about 5 percent by December but said the need to tighten monetary policy would not be required while the Central Bank continues to persuade commercial banks to increase lending to the private sector as the credit squeeze continues with government attracting more commercial bank lending.

Latest data coming out of the Central Bank shows that net credit to the government has increased by 90.7 percent from Rs. 399.9 billion as at July 2008 to Rs. 762.6 billion as at July 2009, while credit to the private sector has declined by 2.1 percent to Rs. 1.203 trillion from Rs. 1.229 trillion. Net credit to corporations increased by 2.1 percent to Rs. 44 billion.

"With the onset of the global financial crisis foreign inflows (to cover the budget deficit) was limited. Even this year, foreign financing of the budget deficit is significantly low and this is why the government has to borrow from domestic sources," Chief Economist of the Central Bank, K. D. Ranasinghe told the Island Financial Review.

With high inflation last year where the 12 month moving average was 22.6 in December, the Central Bank pursued a tight monetary policy stance in a bid to curtail the growth of credit. But the bank began to loosen its policy stance after the rate of inflation began to decline.

The rate of inflation declined to its lowest last August with the point-to-point change in inflation being 0.7 percent and the annual average 6.6 percent.

Treasury bills rates have declined by 7.95 percent since the beginning of the year while Treasury bond rates declined by 9.56 percent.

Last month the Monetary Board of the Central Bank cut policy interest rates by 50 basis points each. The Repurchase rate and the Reverse Repurchase rate of the Central Bank is now 8 percent and 10.50 percent, respectively. The statutory reserve requirement for commercial bank deposits was also reduced to 7 percent this year. Penal rates were also abolished.

Commercial banks have responded. The Average Weighted Prime Lending Rate has declined to 12.88 by last week from 21.19 a year ago. But this rate signifies the rate at which commercial banks lend to their ‘prime’ customers, their high net-worth clients.

Commercial bank dealers admit that increasing lending to the private sector at this stage is not something banks are comfortable to do, opting rather to invest in government securities; a risk free investment.

Lending could pick up...

Ranasinghe said the Central Bank was continuously asking commercial banks to increase their lending to the private sector.

"This is something we often keep telling them," he said.

However, Ranasinghe said lending to the private sector could pick up later during the year, especially when US$ 500 million Sovereign Bond issues comes through later this month.

"This will greatly reduce the government’s need to borrow from domestic sources and then commercial banks will be in a position to lend more to the private sector. Also, domestic demand is bound to recover once the global situation begins to ease," he said.

Inflation up, rates stable...

Ranasinghe said the rate of inflation is expected to pick up to about 4 or 5 percent by the end of the year once the global economy begins to recover with import prices bound to increase.

If inflation starts increasing and the Central Bank tightened its monetary policy stance, the private sector could once more face a situation where interest rates are too high. At the moment commercial bank lending rates are low (there is still room to come down further) but they are unwilling, it seems, to lend.

"We have forecast inflation to increase by the year end, but it will not be necessary to tighten monetary policy because real interest rates would still be positive (broadly, nominal interest rate minus inflation)," Ranasinghe said.