Wednesday, November 24, 2010

Sri Lanka presses banks to lend long-term

Nov 23, 2010 (LBO) - Sri Lankan banks should provide more long-term loans and tax cuts in the government budget for 2011 are meant to encourage longer maturity lending, finance ministry secretary P B Jayasundera said.

Key sectors of the economy like tea and rubber, where cultivators must wait several years for the first harvests, need longer-term lending, he told a forum on the budget organised by the Ernst & Young audit firm.

"We need bank balance sheets to correspond with the real economy and the real economy needs money," Jayasundera said.

"Bankers must look beyond what they've been doing - mainly lending for short-term working capital requirements or 2-3 year lending - to 10- 15 year capital."

Macro-economic Instability

Analysts have said Sri Lanka's lack of long term lending is due to excessive volatility in interest rates, coming primarily from massive deficit spending and uncontrolled inflation which feed on each other.

Most long term capital in the form of pension funds of private sector workers is also taken by the state for deficit spending.

Money borrowed by the state from the people, has largely been miss-spent over several decades resulting in national debt growing to around 80 to 100 percent of GDP by the last decade.

A post-2004 deficit spending bout eventually pushed interest rates over 20 percent by end 2008. Now rates are below 10 percent.

To survive such shocks banks have to keep both its deposits and loans at short tenors to prevent maturity mis-matches.

Negative Real Rates

Depositors are also unwilling to go for long tenors due to uncertainty about inflation. Sri Lanka's high nominal rates of interest can even be negative in real terms. In 2007 Sri Lanka inflation went above 29.9 percent and the state changed its inflation index.

When an administration changes and deficits suddenly expand, living beyond the capacity of the people to bear it, inflation and interest rates can go haywire.

However the state has promised to cut the budget deficit to 6.8 percent of gross domestic product in a budget for 2011, down from over 10 percent in 2009.

Jayasundera said those doing research and development, which the government wants to encourage, also must wait for years before getting a return for their efforts.

"Those things cannot be done through credit card borrowings at 30 percent. We need 5-6 percent private credit."

Sri Lanka's inflation is still over 6.0 percent, but the level is substantially below levels seen earlier. Sri Lanka's inflation has been high due to deficit spending, and central bank money printing to finance such deficits.

Though rates have come down in recent months banks have been reluctant to lend, citing the lack of bankable projects.

Capital Projects

Jayasundera said tax cuts for banks and the corporate sector in general announced in the 2011 budget Monday were meant to free up capital for lending and investment.

Banks must put in the equivalent of 8.0 percent of financial value added tax to an investment account with Sri Lanka's central bank for three years, according to the budget proposals.

"We have created an investment fund account which will basically divert these differences in taxes for a period of three years to build long-term capital which will be guided under central bank regulations and the department of inland revenue," he said.

This will "ensure tax savings will not go for simple distribution of dividends from profits or taken back to various headquarters or to build (bank) headquarters here but to lend for a wide range of economic activities that this budget expects," Jayasundera said.

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