The unprecedented move designed to stimulate Sri Lanka’s economy

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As part of efforts to stimulate the economy, the Central Bank of Sri Lanka has taken the unprecedented step of ordering lenders to reduce their interest rates.

On September 24 the institution’s Monetary Board, the country’s primary financial regulator, announced that all commercial banks were to reduce lending rates by a minimum of 200 basis points by October 15.

In addition, as of November 1 credit card advances will be subject to a maximum interest rate of 28% per annum, while pre-arranged overdrafts will have a maximum rate of 24%.

The announcement followed government complaints that commercial lending rates had not been reduced in line with policy rates.

The benchmark rate was slashed – for the first time since 2015 – by 50 basis points in both May and August to where it currently sits, at 7%. Over the same period the central bank made a 100-basis-point cut to the rate at which it lends to commercial banks, bringing it to 8% in August.

The September move was the first time since the central bank’s inception in 1950 that it had ordered lenders to reduce rates and imposed a ceiling on interest.

See also: The Report – Sri Lanka 2019

Stimulating credit growth

This development comes amid efforts to stimulate credit growth and economic activity, which have suffered following the Easter terrorist attacks in Colombo.

After 3.2% growth in 2018, which was the lowest rate in 17 years, officials had expected the economy to rebound with an expansion of 3.6% this year; however, the April 21 bombings dampened projections.

In late May Eran Wickramaratne, the minister of finance, told local media that he expected growth of 3% for 2019. Meanwhile, government officials predicted that the tourism sector, the third-largest source of foreign exchange, could suffer losses of up to $1.5bn this year as a result of cancelled bookings, although the industry expects this figure to be lower.

The central bank said a slowdown in the economy following the attacks had “intensified the need for lower lending rates”, as had the sharp drop in credit growth seen in the private sector since the beginning of the year.

“Sri Lanka’s economy needs to be growing at around 5% per year to reach its potential,” Bingumal Thewarathanthri, CEO of Standard Chartered Sri Lanka, told OBG. 

“To help enable this, banks need to look at ways to extend more credit to private companies operating in the most productive sectors of the economy. Now is the time to identify the next 100 companies capable of generating growth and expanding into Asia and Africa.”

The need for stability

In addition to cheaper credit, stakeholders have called for a stable policy approach to ensure growth.

“While forcing down interest rates can be seen as a positive for the economy… many businesses and investors look at a range of metrics when considering expansion and growth,” Dilshan Wirasekara, director and CEO of First Capital Holdings, told an OBG-hosted roundtable in Colombo in mid-September. “Policymakers must therefore ensure price stability as well as policy certainty, so that businesses and investors are well informed as to the country’s strategic plan and direction.”

The call for policy stability comes ahead of this year’s presidential election, scheduled for November 16, as business officials hope to avoid a repeat of the political insecurity of 2018.

Citing policy differences, in October last year President Maithripala Sirisena rescinded the mandate of Prime Minister Ranil Wickremesinghe, despite the latter maintaining the support of a majority of members of Parliament.

Although the Supreme Court reinstated Prime Minister Wickremesinghe on December 16 following a ruling in his favour, the leadership crisis weakened business sentiment and was widely regarded as having a negative impact on growth that was already slowing towards the end of the year.

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