Friday, 7 April 2023 00:00 –      – 11

Money printing by the Central Bank creates liquidity that at times is needed and enables the smooth functioning of the economic machine. However, when done for purposes that create adverse consequences, it can result in inflation and artificially low-interest rates as a result of what is known as excess demand for money, in the system.

Due to these low rates, which last year ran to around 7%, Small and Medium Enterprises are facing higher interest rates. Coupled with a drop in demand as a result of the currency crunch, wage workers and retirees are facing lower discretionary incomes after taxes as total costs rise to the detriment of these SMEs.

When the interest rates were very low, businesses went and borrowed at 7% interest without realising that some of those are mentioned as variable interest rates in the covenant. What this means is as it is linked to a baseline rate, usually the Prime lending rate meaning the weighted average rate at which commercial banks lend to their least risky clients. With the baseline rate changing and increasing, the loan interest rate readjusts higher, to the demerit of the borrower, who must now pay back a higher interest, where in some cases the borrowed money was utilised in low-return generating ventures

This now comes as a result of the Board’s January 2021 decision to implement priority sector loan goals for the MSME (Micro, Small, and Medium Enterprise) sector in collaboration with the financial sector, the central bank stated in its January monetary policy statement, where a policy corridor of 4.5% to 5.5% was kept. This was at a time banks and other lending institutions took it upon themselves to aggressively expand their lending portfolios to factor in the low margins at the time.

According to some experts on the matter, this situation is even more precarious than the tax rate hikes. As early as February Central Bank Governor Dr. Nandalal Weerasinghe expressed that Sri Lanka’s  banks should consider restructuring debts to salaried workers affected by progressive taxation, as progressive income taxes were applied at lower levels in the aftermath of a sovereign failure.

Picketing state company executives and other employees of such agencies as the Sri Lanka Port Authority have complained that high progressive taxes were sending their bank accounts into overdraft after loan payments were reduced. Since the International Monetary Fund provided technical help to the central bank to compute potential output; the theoretical output level at which all factors of production are economically utilised.

Sri Lanka has experimented with output gap targeting, providing the ideal chance for the country’s  trigger-happy economic officials to create money. When reserves are collected and the exchange rate is either targeted or allowed to float any inflation targeting through inflationary open market operations term leads to forex shortages and the currency collapses. The open market operations mentioned refer to overnight reverse repo auctions and outright purchases of bills and bonds.

Considering this some have also reignited requests from the President to set up a bad loan recovery plan. In November last year, President Wickremesinghe proposed that asset management firms will buy bad debts at a discount and concentrate on debt recovery. Banks must sometimes recapitalise these expenses, sometimes at the cost of the government, to compensate for deficits. Banks may also face losses from local debt restructuring in addition to mark-to-market losses.