Central Banks Monetary Policy Review: Is

there a hidden macroeconomic anomaly?

The monthly monetary policy review-September 29,
2014
The Central Bank issue its monthly !onetary "olicy #eview on 2$
September 2014 %available at
http&''www(cbsl()ov(lk'pics*n*ocs'02*prs'*ocs'press'press*2014092$e(p+
, !onetary "olicy #eview, September 2014,( The statement has presente
an analysis o+ evelopments which the Bank has ienti-e as bene-cial to
Sri .anka be+ore announcin) the policy chan)e which it has introuce in
the month(
The covera)e o+ the perio relatin) to these evelopments has i/ere
+rom one -el to another perhaps ue to the problem o+ non-availability o+
upate ata( 0ccorin)ly, )rowth has been analyse pertainin) to the -rst
hal+ o+ 2014( The evelopments relatin) to e1ternal trae an balance o+
payments an those relatin) to money supply have been analyse with
respect to the -rst seven months o+ the year( The chan)e in the in2ation
rate has been presente up to the en o+ 0u)ust, the latest month +or
which the relevant ata ha been available(

"unishin) banks +or parkin) their e1cess money continuously
Base on these analyses, the Bank has introuce its monetary policy
chan)e pertainin) to the acceptance o+ e1cess money available with
commercial banks as a temporary eposit with the Central Bank uner its
new Stanar 3eposit 4acility, also known as S34( 5n this +acility,
commercial banks can keep their e1cess money in eposit with the Central
Bank at an annual interest rate o+ 6(78( 9owever, they o not )et a
security +or such eposits +rom the Central Bank as in the case o+ a #:";
transaction where the Central Bank )ives away the Treasury bills +rom its
holin)s(
The Central Bank has accuse commercial banks o+ usin) S34 continuously
to park their e1cess money < money available a+ter lenin) to customers
an to other banks < with the Central Bank instea o+ lenin) to customers(
To iscoura)e them +rom oin) so, the Central Bank has chan)e the rules
o+ the )ame( =ner the new rules, any commercial bank which will use this
+acility +or more than $ times a calenar month will be pai a lower interest
rate at 78 per annum, a kin o+ a penalty impose on banks +or their wron)
behaviour( Thus, commercial banks which have been accuse o+ bein) la>y
in lenin) have been +orce to )o out to the market an start lenin) their
e1cess money to the public instea o+ makin) easy money with the Central
Bank(
Thumpin) pro-ts o not testi+y to the presume la>iness o+ banks
The Central Bank has observe that the creit to private sector by
commercial banks has remaine ?moest@ in the last 12 months( Ahat the
Bank has terme moest is the sta)nant position o+ private sector creit at
about #s 2(7 trillion between Buly 201$ an Buly 2014( This has happene
espite the Bank@s reucin) interest rates to promote creit as a part o+ its
loose monetary policy in the last two years or so(
To promote creit in the economy, the
Bank ha continuously reuce its
policy interest rates which in turn ha
cause commercial banks to reuce
their lenin) an eposit rates(
9owever, the reuction in lenin) rates
is e1pecte to promote creit by
increasin) the eman +or creit by
borrowers( But the creit to private
sector has remaine obstinately
sta)nant when all other economic
inicators ha shown a robust )rowth
as claime by the Central Bank( There
coul only be one reason +or this +reak
outcome( That is, borrowers woul have
2ocke in +ront o+ banks to borrow
money but banks woul have sent them
away( That was because banks were more intereste in earnin) easy money
by epositin) their e1cess money with the Central Bank(
The interest rate which banks coul earn by resortin) to that practice is
6(78( This rate is ?e1tremely moest@ compare to the hi)h income they
woul have earne by lenin) in the market as emonstrate by the
wei)hte avera)e lenin) rates o+ commercial banks stanin) between 14
to 168 in the last 12 months accorin) to the Central Bank@s latest weekly
economic inicators %available
athttp&''www(cbsl()ov(lk'pics*n*ocs'*cei'*ocs'ei'wei*20140926(p+,( 5+ a
pro-t seekin) bank chooses 6(78 over available opportunities at more than
two times that rate, such commercial bank is surely a la>y bank an nee
be woken up( 9owever, the thumpin) pro-ts measure in billions o+ rupees
earne by the entire bankin) system in the last +ew years o not testi+y to
their bein) la>y in lenin) or oin) business(
Aa)in) an interest rate war with banks
5t now appears that the Central Bank has entere into an ?interest rate war@
with the entire -nancial market o+ the country( Ahen banks i not len
money to the private sector as e1pecte by the Central Bank, it starte to
reuce its policy rates in several rouns( 0ccorin)ly, its #:"; rate < the
rate at which it accepte the e1cess money o+ commercial banks by )ivin)
away the Treasury bills it ha as collateral < was reuce +rom C(C78 in mi
2012 to 6(78 by en 201$( This was the rate which was continue uner
the Central Bank@s new S34 introuce in early 2014(
0lon) with the reuction in policy rate in each roun, all interest rates in the
-nancial markets, incluin) the lenin) rates o+ commercial banks, were
brou)ht own appropriately( 4or instance, the interbank call money rate, on
avera)e, came own +rom 10(4C8 in mi 2012 to C(668 by en 201$(
Similarly, the wei)hte avera)e lenin) rate o+ commercial banks came
own +rom 17(9$8 in mi 201$ to 1$(7$8 in mi 2014(
Det, creit to private sector i not )row as e1pecte resultin) in an
accumulation o+ a substantial amount o+ e1cess money with commercial
banks( 5n the last 12 months, this e1cess money ha amounte, on
avera)e, to #s $40 billion( Central Bank@s 3eputy Eovernor, Fanalal
Aeerasin)he, a repute economist himsel+, in an interview with a private
TG channel immeiately a+ter the chan)e in the monetary policy in
September si)nalle that i+ banks will not e1ten creit as e1pecte, the
Central Bank woul +urther cut interest rates( Clearly, with such an interest
rate cut, the +uture will be a borrowers@ market an not a leners@ market(
3iscoura)e epositors will help eliminate e1cess money
Commercial banks on their part have been min+ul o+ this reality( They are
competin) with each other to )et the borrowers to their port+olio by
employin) i/erent marketin) tactics( Formally, the situation in any market
woul be +or banks to use such marketin) tactics to attract eposits(
But now, eposit mobilisation at )reat costs has become costly since it oes
not pay enou)h return to banks( 9ence, banks are now iscoura)in)
eposits by o/erin) the epositors unattractive very low interest rates
when the maturin) eposits are renewe(
But on the lenin) sie, banks have been senin) their -el canvassers on
motorbikes to push loans on prospective borrowers( .ast week, one such
-el canvasser ha o/ere a lar)e loan to a housin) eveloper at 10(78
per annum( The housin) eveloper has not committe himsel+ to the loan
because he is awaitin) a +urther interest rate reuction by the Central Bank(
9is stan is per+ectly rational since the Bank has si)nalle a +urther +all in
interest rates alon) with the e1pecte ecline in in2ation rate( 0s such, the
market e1pectation is that Sri .anka will move towar a >ero interest rate
re)ime like the re)ime +oun in Bapan, :=, the =H an =S0(
The si)ns +or such a movement were evient when the Central Bank
impose the penalty interest rate on S34 i+ banks use that +acility +or more
than three times a month( Showin) that all banks ha been in this )ame,
the entire short term interest rate structure came own by a si)ni-cant
mar)in immeiately& Call money rates +rom 6(698 to 6(228, #:"; market
outsie the Central Bank +rom 6(728 to 6(0$8, 1 year Treasury bill rate
+rom 6(298 to 7(I98, Aei)hte avera)e yiel on Treasury bons +rom
10(7I8 to 9(2$8, an FSB 1 year -1e eposit rate +rom C(78 to 6(78(
To match these savin)s rates, the lenin) rates o+ commercial banks too
have +allen by a si)ni-cant mar)in& Aei)hte avera)e prime lenin) rate
that is applicable to best customers o+ banks +rom C(178 to 6(C78 an
wei)hte avera)e lenin) rate +rom 1$(I$8 to 1$(7$8( 0ccorin)ly, the
Central Bank@s policy chan)e has subsiise borrowers while ta1in) the
savers( 9owever, it appears that this subsiy is not attractive enou)h +or
borrowers to show up in banks because they are waitin) +or +urther interest
rate cuts( 5n this scenario, the e1cess money will eventually isappear when
iscoura)e savers woul take their money out o+ banks(
5ncrease consumption will increase the import bill
Ahat will the savers o with their money in hanJ They will simply use it +or
boostin) consumption as has been one in other countries where interest
rates ha been brou)ht to >ero level( Sri .ankans have always been hi)h
consumers, usin) about I28 o+ their income +or consumption( This new
measure will +urther boost that consumption habit o+ +ellow citi>ens( 0n
what will they consumeJ They have a hi)h tenency +or consumin)
importe proucts an there+ore it will boost the import bill as well( The
likely caniates are smart phones, lar)e 2at TG screens, 9ybri cars an
+orei)n travel +or pleasure which are vo)ue in eman in the present ays(
The outcome is the reversal o+ the current contraction o+ the combine
trae an services e-cit puttin) pressure +or Sri .anka to borrow more to
)enerate its much praise surplus in the balance o+ payments( 9ence, in an
open economy where the omestic market is small, boostin) consumption
by iscoura)in) savin)s will not be an avisable policy stance( 5t will create
a serious anomaly in the country@s macro economy(
Creitless )rowth@, the marvel o+ Sri .anka
But, +rom another sie, shoul the borrowers be subsiise by the Central
BankJ 5t appears that they shoul not be( This is because, espite the
sta)nant private sector creit levels, Sri .anka@s economy has recore an
impressive )rowth in the past 4 Kuarters( 5ronically, it can there+ore be
labelle a ?creitless )rowth@ which the economy has attaine without the
support +rom the creit sie( 0ccorin) to the estimates o+ the 3epartment
o+ Census an Statistics or 3CS, Sri .anka@s economy has )rown by C(68 in
the -rst Kuarter o+ 2014( This was accelerate to C(I8 in the secon
Kuarter http&''www(statistics()ov(lk'national*accounts'"ress
820#elease'3CS-E3"-2014-L2(p+(
This )rowth has basically come +rom inustry which has )rown by 128,
construction by 208, omestic trae by 108, post an telecommunication
by 108, bankin) by 68 an )overnment services by another 68( :1cept
the )overnment an bankin) sectors, all other sectors are hi)hly creit
epenent sectors( 5+ they can recor these impressive )rowth rates as
claime by 3CS with sta)nant creit levels, bank creit is unnecessary +or
boostin) the economy( 5n this sense, Sri .anka@s creitless )rowth is an icon
+or the rest o+ the worl since no country has recore such a marvel in the
past( Countries ha ha creitless recoveries but not creitless )rowth( 0s
such, the current obsessive pursuit o+ promotin) creit by reucin) interest
rates appears to be unnecessary(
0nomalous )rowth numbers by 3CS
Thou)h 3CS has come up with an impressive )rowth recor, the
e1amination o+ some o+ the hi)h )rowth -els shows that the rates reporte
o not tally with other available economic inicators( ;ne e1ample is the
)rowth in the +actory inustries( 0ccorin) to 3CS, the +actory inustry
sector has recore a )rowth o+ 118 in the secon Kuarter o+ 2014( But
accorin) to the Central Bank@s +actory inustry prouction ine1 as
reporte in its weekly economic inicators re+erre to above, the prouction
level has remaine sta)nant at 10I between !ay 201$ an !ay 2014( 5n
the case o+ wearin) apparels o+ which 3CS has recore an impressive
)rowth o+ 168, the Central Bank@s ine1 shows a ecline o+ 78 in
prouction( 0 similar anomaly is +oun in the construction sector too(
0ccorin) to 3CS, this sector has )rown by 208 in the secon Kuarter o+
2014( But the import o+ builin) materials, vehicles, machinery an
eKuipment has ecline in that Kuarter compare to the relevant Kuarter in
the previous year by 148( 9ence, the presumption is that the entirety o+
the construction that has happene in the Kuarter uner re+erence has
come +rom omestic sources which +act is hi)hly unlikely( 5n the transport
sector o+ which the #ailways have been runnin) at a hu)e e-cit, a )rowth
o+ 78 has been recore implyin) that it has mae a positive value
aition( 5t is there+ore evient that appropriate cross-checkin) an
veri-cations have not been one by 3CS be+ore releasin) its )rowth
numbers( 0pparently, the Central Bank too has accepte these numbers
without makin) an inepenent compatibility analysis(
Banks an epositors are bein) punishe +or the policy-create anomaly in
the macro economy
The money supply an reserve money numbers also show a
macroeconomic anomaly( The monetary policy statement o+ the Central
Bank uner re+erence has reporte that the -nancial account o+ the balance
o+ payments has recore a surplus o+ over =SM 2 billion urin) the -rst C
months o+ 2014( This surplus is ientically eKual to the increase in the net
+orei)n assets o+ the Central Bank urin) this perio( 0ccorin) to numbers
reporte in the weekly economic inicators an the Central Bank 0nnual
#eport 201$, the net +orei)n assets o+ the Central Bank has increase by #s
214 billion or =S M 1(6 billion urin) this perio showin) a iscrepancy o+
=SM 400 million( 0t the same time, #eserve !oney < money prouce by
the Central Bank by acKuirin) +orei)n e1chan)e an lenin) to the
)overnment on a net basis an use by commercial banks to create
multiple eposits an creit < has increase +rom #s 4I9 billion at en-201$
to #s 724 billion at en-Buly2014( Since the Central Bank@s net creit to
)overnment has increase only +rom #s 114 billion to #s 141 billion urin)
this perio, the entirety o+ the increase in reserve money has taken place
ue to an increase in its net +orei)n assets( This is however on the
presumption that all other miscellaneous operations o+ the Central Bank
have remaine unchan)e( But when the reserve money has increase by
C8, the broa money supply has increase by 128, inicatin) that
commercial banks have starte creatin) multiple eposit an creit in the
system which will be complete over the ne1t 12 to 1I month perio( But
who has use that creitJ 0ccorin) to the Central Bank@s monetary policy
statement, it is the )overnment which has use that creit )iven that public
corporations have repai some o+ their borrowin)s an the private sector
creit has remaine sta)nant( 0ccorin) to the ata release by the Central
Bank, lenin) o+ banks to the )overnment has increase by #s 17$ billion
between en-Buly 201$ an en-Buly 2014( Thus, the Central Bank has
acKuire net +orei)n assets throu)h the borrowin)s o+ the )overnment an
other )overnment a)encies to buil reserve money in the economy( Such
reserve money has basically been use by banks +or lenin) back to the
)overnment at the e1pense o+ the private sector( Fow banks an savers are
bein) punishe ue to this policy-initiate anomaly create in the country@s
macro economy(
0n elephant in the roomJ
5+ banks are +orce to len to the private sector throu)h policy initiatives,
they will lower their creit stanars creatin) a creit snowball similar to
the creit bubble that hit the =S economy prior to the -nancial crisis o+
200C-0I( Since the economy is unable to sustain this creit snowball, it
woul start to meltown in no time( 5t is an invitation +or an unwante
-nancial sector crisis in the country(
Thus, the obsessive pursuit o+ promotin) private sector creit by istortin)
interest rate structure has create an elephantine macroeconomic anomaly(
But the elephant is not out in the wil( 5t is ri)ht insie the room an its
threat shoul not be i)nore(
%A(0 AiNewarena, a +ormer 3eputy Eovernor o+ the Central Bank o+ Sri
.anka, can be reache at waw1949O)mail(com ,