THE CREDIT CYCLE
PRIVATE SECTOR CREDIT GROWTH WARNING
Shiran Fernando analyses trends in private sector credit and concludes on a cautionary note
Private sector credit – classified as credit disbursed by commercial banks to private sector players in sectors such as agriculture, industry and services – has witnessed accelerated growth for some years. This growth offers a sense of the demand conditions in the economy and which sectors are attracting borrowings.
But consistent overall annual private sector credit growth of above 15 percent is a concern given that it hasn’t been a sustained rate and isn’t without negative impacts on the national economy.
INTEREST RATES We often experience an up-and-down credit cycle that is influenced by the movement in interest rates. If there is a period of low interest rates, it’s often followed by an increase in private sector credit albeit with some lag.
It takes a while for low interest rates to spur growth in credit as consumers become used to the status quo.
Following a sustained period of low rates, credit to the private sector usually rises above 15 percent growth on a year-on-year basis.
This worries the Central Bank of Sri Lanka (CBSL), which then attempts to cool credit growth and other demand pressures that build up in the economy by increasing interest rates. Once again, it takes a while for this to have a real effect on credit growth.
CREDIT CYCLE The most recent cycle began in July 2013 with the CBSL reducing the Statutory Reserve Requirement (SRR) for banks – the SRR refers to the mix of rupee-deposit liabilities that commercial banks are required to maintain as a deposit with the CBSL. Through this initiative, the Central Bank began a period of monetary policy easing together with an indication that interest rates should head downward.
This was followed by reductions in policy rates – i.e. the Standing Deposit Facility Rate (SDFR) and Standing Lending Facility Rate (SLFR). The reductions occurred between October 2013 and April 2015 with the SDFR and SLFR being cut by one and 1.5 percent respectively.
Meanwhile, private sector credit picked up only after August 2014 in response to the easing of monetary policy that began more than a year ago. But this growth has been sustained; in fact, it surged in 2015 and 2016.
In absolute terms, credit grew by Rs. 691 billion in 2015, coming in at 755 billion rupees last year. This followed two years in which credit growth was weak – e.g. years 2013 and 2014 recorded absolute growth of Rs. 176 billion and Rs. 224 billion respectively.
SLOW RESPONSE When the CBSL witnesses such high credit growth numbers, it resorts to cooling by raising key policy rates. The bank has been doing so since December 2015 with the most recent hike in policy rates being announced in its monetary policy review in late 2016.
But credit growth is yet to come under 20 percent on an annual basis with March recording 20.3 percent growth.
This slow transmission of policy rates to a slowdown in credit has worried the CBSL. It expected credit to be under 20 percent growth on an annual basis by end-2016 – this despite key market rates like the Average Prime Lending Rate (APLR) and 12-month Treasury bill yield increasing by 3.99 percent and 2.87 percent respectively last year.
GROWTH DRIVER Key drivers of this growth in the recent upward trend in the cycle have been the construction industry, the wholesale and retail trades, and personal loans and advances.
The low interest rate environment between July 2013 and late 2015 along with more lax fiscal policy has provided the impetus for growth during this period. The most substantial absolute growth in credit last year came from construction, which advanced by Rs. 172 billion – growth that is reflective of the industry witnessing a sharp rise in activity in the real estate market with increased construction and apartment sales.
This sharp rise has been a cause for concern for the CBSL. In February, the Governor of the Central Bank stated that this was being studied “very carefully.” The worry with excess credit growth is the repayment factor given that we are now in a higher interest rate environment.
SO WHAT’S NEXT? Following the increase in interest rates over more than one and a half years to slow credit growth, we can expect the CBSL to continue to remain cautious for the rest of the year.
Past cycles such as that of 2010-2013 suggest that one of the lag factors that exist is the transmission from policy to reality. CBSL should also be mindful that if it tightens monetary policy too much, it may stall credit for even longer… as it has done in the past.