12. FINANCIAL SECTOR. Monetary Policy

Transcription

1 12. FINANCIAL SECTOR The financial sector moved further forward, supported by recovery in economic activity. The Central Bank reduced its policy rates, facilitated by the decline in both inflation and inflation expectations and monetary growth remained within projections. In monetary management, the Central Bank moved to more active Open Market Operations in March 2003 to meet the day-to-day liquidity mismatches in the system, containing volatility in short-term money market rates and achieving the base money targets as programmed. The domestic rupee market remained liquid and market interest rates declined further. The yield curve for government securities flattened and shifted down with long-term bond rates declining at a faster pace. Within the banking sector, there was a move toward consolidation and a greater use of information technology. However, interest spread in the banking sector widened. Financial system stability improved with a further strengthening of prudential regulation and the resolution of difficulties in weaker banks. A Real Time Gross Settlement (RTGS) System was implemented in September, to strengthen further and expanding the payments and settlements system. The upsurge in stock market activity, brought about by investor optimism about economic prospects, was maintained, with several key market indicators reaching record levels. Monetary Policy The focus of monetary policy continued to be on providing adequate liquidity to support economic recovery and to avoid the build up of inflationary pressure. The Central Bank revised downward its policy rates in three steps by September With a view to facilitating more effective management of market liquidity and to achieve its monetary policy objectives, the Central Bank moved to more active open market operations (OMO), in March The Central Bank reduced its Repurchase (Repo) and Reverse Repurchase (Reverse Repo) rates by 225 basis points in three steps in January, May and August. The reduction in inflation and inflationary expectations, the maintenance of monetary aggregates within the expected level, the containment of public sector (i.e. government and public corporations) borrowing, the availability of liquidity in the rupee market, relative stability in the foreign exchange markets, and downward movements in international interest rates were the underlying factors for the reductions in policy rates. The Bank Rate (i.e., the rate applicable for lending to commercial banks under special circumstances) was also reduced. The Central Bank moved to more active OMO, from 03 March Key features of the new system are a daily auction to inject or absorb liquidity, an interest rate corridor formed by the Bank s Repo and Reverse Repo rates and standing facilities to participants at these rates. Under this system, the volume of liquidity to be injected or absorbed under OMO is decided daily by the Central Bank, based on the monetary plicy stance and market liquidity situation. The method of computing the statutory reserves maintained by commercial banks with the Central Bank was changed with effect from 03 April 2003, with a view to improving the effectiveness of SRR and the estimation of daily market liquidity, which is a vital for the efficient working of open market operations. The monetary policy stance is reviewed on a regular basis, usually at monthly intervals, and a statement on the Central Bank s monetary policy stance is made public, in order to increase market awareness and improve financial market stability by giving reasons behind the policy decisions. An Advance Release Calendar of these monetary policy announcements was released to the public to further improve market certainty in monetary policy operations. 68

2 Liquidity Conditions and Open Market Operations Money market liquidity increased on account of the purchase of foreign currency by the Central Bank from the market to augment official reserves, the sales of foreign loan receipts by the government to the Central Bank, and improved cash management in the government. The market liquidity surplus was around Rs.10 billion through much of the first three quarters of assets (NFA) during January - August 2003 increased significantly, the sharp reduction in holdings of government paper by the Central Bank through active open market operations, and improved government Treasury cash management enabled reserve money to be kept within the targetted level. Since the commencement of more active OMO, the Central Bank has conducted auctions for repurchase transactions almost daily, as there was excess liquidity in the market. The daily auctions were on an overnight basis. The Central Bank also began conducting outright sales to absorb liquidity on a longer-term basis. Table 12.1 Policy Interest Rates of the Central Bank (percent per annum) Date Repo Reverse Bank Rate Repo Rate Rate Dec Dec Dec Jan May Aug During the first eight months of 2003, the NFA of the monetary authority increased by Rs.29 billion, due to purchases of foreign currency. Meanwhile, net domestic assets (NDA) of the monetary authority declined by about Rs.20 billion mainly due to the decline in Central Bank s holdings of Treasury bills by Rs.30 billion. Accordingly, reserve money increased by Rs.9 billion and reached Rs.135 billion by end August as against the target of Rs.137 billion. Source: Central Bank of Sri Lanka In view of excess liquidity, the weighted average yield rate at the auction stayed close to the Repo rate and below the average call money rate and overnight repo rates outside the Central Bank. The yield rate at the auction, which was around 9.25 per cent at the commencement of more active OMO, came down to 7.58 per cent at end September. The Central Bank also issued its own securities for OMO in September to mop up liquidity as its portfolio of government paper had dwindled. Money and Credit Developments Reserve money, which is the operating target for monetary policy, against which the monetary programme targets are set, was maintained within the projected limits. Although the net foreign Money Supply The growth in consolidated broad money per cent, in line with the monetary programme for Increase in both NFA and NDA, contributed, although two thirds of the growth was contributed by NFA. The comparatively slow growth in domestic assets was due to a reduction in the public sector borrowing and slow growth in credit to the private sector. 69

3 The improvement in NFA of the banking system resulted from increased private remittances, inflows through the services account, inflows on account of portfolio investments, and capital inflows to both the government and the private sector. The increase was largely (88 per cent) reflected in the NFA of the Central Bank. increased by 14.3 per cent on a point to point basis, the increase was below expectations. Table 12.2 Credit to the Private sector from Major finacial Institutions (Rs. bn) (as at end) Licensed Commercial Banks Licensed Specialised Banks Finance Companies Total June Source: Central Bank of Sri Lanka Net credit to the government fell by Rs.17 billion during the first eight months of 2003 and was reflected mainly in the large reduction in the Central Bank s holdings of government paper. The reduction of government liabilities to the banking sector was facilitated by the containment of government borrowing requirements, increases in the receipt of privatisation proceeds and foreign loans, and improved cash management by the General Treasury. The steady and increasing credit to the private sector was in response to the ongoing recovery in the economy and the decline in interest rates, both of which boosted credit demand. The sectors that obtained significant amounts of credit were trade, tourism, housing, consumption and industry. The pick up in private sector credit demand was slightly below expectations. It is expected that the growth in credit during the second half of 2003 would be somewhat faster than in the first half, as the economic recovery gathers momentum and interest rates takes move further down. Credit to public corporations declined mainly due to the reduction in credit to the Ceylon Petroleum Corporation (CPC) and the Ceylon Electricity Board (CEB). CPC was able to reduce its outstanding borrowings due to improvement of its financial position and the continuation of automatic price adjustments CPC s cash flow. CEB was able to borrow less from the banking sector as some costs were reduced with the termination of the generation of some high cost thermal power, and an increase in the relative share of hydro power generation. Credit expansion to the private sector from commercial banks witnessed in 2002 continued during the first eight months of Credit to the private sector increased by Rs.32 billion during the period under review, as against an increase of Rs.21 billion during the first eight months of 2002.Although credit in 2003 had Credit to the Private Sector from Other Major Financial Institutions In addition to commercial banks, licensed specialised banks and finance companies increased credit facilities to the private sector. The increase in credit facilities provided to the private sector by licensed specialised banks was marginal. However, private sector credit extended by finance companies grew 70

4 significantly (10.1 per cent) on account of higher demand for lease financing and slow adjustments in lending rates. Financial Survey The growth in broad money (M4 ) was within a range of per cent during the first half of Based on the financial survey, M4 is a broader measure of money, covering licensed specialised banks and finance companies, in addition to licensed commercial banks and the Central Bank. On average, the growth in M4 was around 14 per cent during the first half of 2003 as compared to 13 per cent in M2b. The relatively higher growth in M4 was mainly due to an increase in NDA in the banking system, which consisted of increased net credit to government (NCG) from Licensed Specialised Banks (LSBs). This increase in NCG from the LSBs was mainly accounted for by increased investment in government paper by the National Savings Bank (NSB). Interest Rates The Central Bank cautiously reduced its policy rates further. Market rates too, particularly shortterm rates, declined; some lending rates still remain high. The Repo rate and Reverse repo rate, which were 9.75 per cent and per cent, respectively, at end 2002 were reduced in three steps by 75 basis points each, to 7.50 per cent and 9.50 per cent, respectively by end September. The Bank Rate was reduced from per cent to per cent effective from August Responding positively, the weighted average call money rate declined from per cent at end 2002 to around 7.83 per cent by end September. Improved liquidity management with the move to more active open market operations has lowered volatility in the call market. A similar reduction was seen in the overnight SLIBOR rates. The yield curve for government securities has shifted down across all maturities, consequent upon the gradual reduction in policy interest rates by the Central Bank and a decline in inflation and inflationary expectations and cautious borrowing by the government. The declining trend in interest rates also enabled the issue of Treasury bonds with longer term maturities, viz. 10 year and 15-year Treasury bonds, extending the benchmark yield curve. The need to extend the yield curve to reduce rollover risk and provide a benchmark for pricing longterm debt securities in the market has been a long felt need in the domestic debt market. The lending rates of commercial banks, such as rates on overdrafts and export bill financing, also declined commensurately over the period under review. However, some lending rates, and interest margins continue to remain high, reflecting weak interest rate competitiveness in the banking system, the overhang of non performing loans and high operational costs in the banking system. The Central Bank began publishing the lending and deposit rates of individual commercial banks in order to create greater public awareness and thus increase competition. As inflation and expected inflation 71

5 decelerated at a faster rate than the decline in some lending rates, real interest rates on certain categories of loans have increased. The average interest spread which is the difference between the average interest yield and average interest cost of the banking sector, widened further during The average interest yield is defined as total interest income as a per cent of total interest earning assets while the average interest cost is defined as the total interest payments as a per cent of total deposits and borrowing. By the end of the first half of 2003, the average interest spread in the commercial banking sector was about 4.3 percentage points in comparison to 4.0 percentage points at end A spread of this magnitude is high when compared with the spread observed in other countries in the region and developed countries. Payments and Settlements System: Further progress was made towards upgrading and modernising the payments and settlements system in view of its key function in improving efficiency and reducing risks of financial intermediation, and raising financial stability. One major initiative was the introduction of the Real Time Gross Settlements (RTGS) System on 08 September A Scripless Securities Settlement System (SSSS) for government securities will become operational in the last quarter of Banking and Finance The operations of the commercial banking sector improved with both deposit taking and lending activities increasing in the first eight months of 2003, compared with the corresponding period in the previous year. The commercial banking sector continued to show high profitability in the first half of 2003, arising from the widening spread between average deposit and lending rates as well as increasing intermediation activities with the economic recovery. Meanwhile, the CBSL further strengthened the supervisory and regulatory framework. Rupee deposits held by commercial banks increased by 13.1 per cent during the 12 months ending August Continued economic recovery and higher incomes of households and corporations contributed to this growth. Total foreign currency deposits increased by US dollars 107 million during the 12-month period ending August Higher worker remittances, increased export proceeds, improved stability in the exchange rate, and the decline in interest rates in international markets contributed to that increase. Loans and advances of commercial banks grew during the period under review, with an increase of 8.1 per cent during the 12 months ending August However, this growth was slower than the growth in deposits, and the percentage of loans and advances to total deposits declined from 89.5 per cent at end August 2002 to 84.8 per cent at end August Excess liquidity in the banking system increased further. A number of banks earned higher profits in the first half of 2003 than in the corresponding period in The pre-tax profits of commercial banks during the first half of 2003 are estimated to have increased by Rs.2 billion or 37 per cent over the first half of This growth came mainly from increased net interest income. The major reason for the increase in net interest income was the faster decline in average interest expenses, than the decline in average interest income. Noninterest income grew by 27 per cent; however, its share in total income remains relatively low at 18 per cent. Foreign Currency Deposits Total foreign currency deposits increased by US $ 80 million during the first eight months of 2003 from US $ 1,248 million at end 2002 to US $ 1,328 million at end August Following the fall in US policy rates, the interest rates paid by commercial banks on dollar deposits came down by about basis points during the first half of the year. Deposit rates ranged between per cent and per cent, respectively, for savings and one year fixed 72

6 deposits. Depositors received a small premium above international rates, which partly contributed to the rise in foreign currency deposits. Table 12.3 Foreign Currency Deposit Rates (percent per annum) Month/ Savings Rate Fixed Deposits US -Fed Year US$ Rate (1yr)US$ Funds Rate Dec Dec Jan Feb Mar Apr May June Source: Central Bank of Sri Lanka Commercial banks as well as specialized banks operated a number of credit schemes, which are specially designed for small and medium scale industry. Some details of these credit schemes are given in Table To improve the efficiency, robustness and stability of the financial sector, the legal structure and supervision are being strengthened. The risk weighted capital adequacy ratio (CAR) for banks was raised to 10 per cent from the beginning of The liquidity ratios and single borrower limits will be applied on a consolidated basis, i.e., combining both domestic banking units and foreign currency units. A new Banking Act, a Money Laundering Act and an Asset Management Company Act are being drafted. Banking Facilities and Branch Expansion The total number of commercial bank branches increased by 10 in the first half of The ATM network of the commercial banks expanded further by 37, increasing the total number of ATMs to 677 at end June The use of credit cards increased during the fist half of Eight commercial banks continued to issue credit cards. The total number of credit cards issued (net of cancellations) increased by 8 per cent during the first half of (a) Table 12.4 Banking Facilities Year Banking Total Credit Cards Density(a) ATM Issued Machines Excluding Cancellations , , , June ,524 Number of bank branches per 10,000 people Source: Central Bank of Sri Lanka Rural Finance To improve credit delivery, strengthen capacity for borrowing and increase income generating activities in the rural sector and to alleviate poverty, several policy measures taken in the past few years, which include the following have been continuing : - Promotion of people-based micro-finance organisations: Samurdhi Bank Societies and Isuru Development Societies. - Expansion of the Forward Sales Contract System through mobilisation of farmers and buyers and capacity building of participating institutions under the Development Markets Project financed by the World Bank. - Introduction of the concept of futures contract to farmers and buyers under the Forward Markets Promotion Programme. 73

7 Table 12.5 Credit Schemes for the SMI Sector Credit Scheme Banks involved Annual Interest Rate For which purpose Sahanaya Loan Scheme DFCC Bank, Hatton National Bank Sampath Bank, Commercial Bank Maximum of 11.5% For small and Medium scale enterprises Ran Sumituru Credit Scheme Credit Scheme for priority sectors Bank of Ceylon 8.75% Small scale entrepremeurs and professionals Bank of Ceylon 14% For agricultural and industrial activities Indian Credit Line All commercial banks 9.75% For the import of capital goods such as machinery Diriya Landa and Athamaru Schemes Regional Development Banks 9.5% on Initial Capital Small scale enterprised Credit scheme for priority sectors People s Bank % Agriculture, Industries and fisheries - Introduction of new insurance schemes by Agrarian Insurance Board (AAIB) for storage and agriculture, plant and flowers, greenhouses and protected crops and potatoes to protect farmers who cultivate on a commercial scale. - Extension of the poverty alleviation project implemented in the Galle, Matara, Kandy and Puttalam districts to 6 more districts, namely, Hambantota, Kalutara, Nuwara Eliya, Badulla, Matale and Kurunegala under the Poverty Alleviation Micro-finance Project (PAMP). 74

8 Credit Scheme Table 12.6 Other Credit Schemes in Operation Mission Interest Rate for the borrowers (% per annum) Sabaragamuwa Province Integrated Rural Development Project (SPIRDP) Tea Development Project (TDP) Southern Province Rural Development Project (SPRDP) - Revolving fund Credit Scheme North-Central Province Participatory Rural Development Project (NCP - PRDP) and North-Central Province Rural Dev. Project (NCP - RDP) Skills Development Project Matale Rural Economic Advancement Project (M-REAP) Urban Development & Low Income Housing Sector Project (UDLIHSP) Uplift the standard of living of the people in the a Project Province (both the Kegalle and Ratnapura districts) by promoting income generating activities Increase tea smallholders income on a sustainable basis and improve the natural environment in the project area. Improve the quality of life of the people in the Southern province Poverty alleviation, improve food security, nutrition and increase employment opportunities for low income families Improve the quality and relevant skill training programmes to build a quality work force. Permanent increase and sustaining of income of small enterprises of rural and farmer families in the Matale District Increase the accessibility of low income households, whose monthly incme is below Rs to housing finance through the banking sector. 10% AWDR + 2% for replanting, infilling and nurseries AEDR + 6% for other purposes. 12% AWDR + 6% AWDR + 6% 14% Maximum 16% - Further continuation of credit facilities to the rural sector by providing interest subsidies and refinance facilities against loans granted to rural borrowers under donor funded credit schemes. - Introduction of a fee based agricultural extension system under certain credit programmes. - Reduction in interest rates of several credit schemes in 2003, in line with reductions in other market rates of interest. Credit Facilities New Comprehensive Rural Credit Scheme : This is an island-wide scheme, which provides short-term cultivation loans on concessional terms for paddy and subsidiary food crops. An interest subsidy is given by the government. A sum of Rs.956 million was granted under this scheme in 2003.This facility was extended to cover commercial scale seed and planting material production and the purchase of agricultural produce under the Forward Sales Contract System. Further expanding the scope of the scheme, the upper limit of 75

9 credit for paddy purchasing was increased from Rs.2.7 million to Rs.5 million per individual borrower/ buyer with effect from Yala The interest rates under NCRCS were reduced from 12 per cent to 8 per cent per annum. investments of the two funds are in government securities. The total investment in the equity market by the two funds amounted to Rs.2.8 billion (less than one percent of total investment) as at end June The Second Perennial Crops Development Project: The Second Perennial Crops Development Project operates with a facility from the ADB and is designed to support the development and commercialisation of the perennial crop sector by providing credit facilities and support services. Loans disbursed by the end of first half 2003 stood at Rs.971 million under this credit scheme. Surathura Scheme : The Self-employment Promotion through Micro-Enterprise Credit operates with the participation of three lending institutions to increase income and improve living standards of unemployed persons. Under Phase II of this project, which commenced in 1998, banks grant loans out of their own funds at 10 per cent per annum with an interest subsidy of 10 per cent from the government. The amount of loans granted during the period from 1998 to end 2002 stood at Rs.596 million. The interest subsidy paid was Rs.24 million. Insurance Sri Lanka Insurance Corporation Ltd., which holds about 40 per cent of the market share in both life and general insurance business was divested in April 2003, thereby removing the government s direct involvement in the insurance industry almost entirely. The total number of firms operating in the industry increased to 12 at end June 2003 from 11 at end December 2002, with the entry of Life Insurance Corporation ( Lanka) Ltd. A contributory pension scheme was established by the government for employees recruited to permanent posts in the public service or provincial government service on or after 01 January The scheme is operated under a tri-partite system consisting of the Central Bank as the fund manager, Secretary to the Treasury as the agency for approving new members and the Department of Pensions as the administrator of the fund. The contributions to the fund by employer and employee are 12 and 8 per cent, respectively. This scheme would help to reduce the burden to the government of an unfunded pension liability in the future. Casual, temporary, contract and daily paid employees are not eligible to become members of the Fund. However, they are members of the Public Services Provident Fund (PSPF). Capital Market Activity at the Colombo Stock Exchange (CSE) improved significantly during this period, with several key market indicators recording peak performance. The improvement in market activity was reflected in all key market indicators such as the share price indices, market capitalisation, the market price earnings ratio and turnover levels. Super-annuation Funds The total fund base of the two retirement funds stood at Rs.335 billion as at end June 2003, of which 89 per cent is in the EPF. The total contributions to the EPF and ETF during the first half of 2003 amounted to Rs.10.1 and Rs.1.7 billions, respectively. The major portion of the Published financial statements of listed companies for the first quarter of 2003 indicated a further improvement in profits, following the 76

10 significant improvement in Favourable trends in key economic variables such as GDP growth, interest rates, inflation and the exchange rate, and continued stability on the political front, following the cessation of hostilities in 2002, are factors that impacted positively on the market. The tax amnesty granted by the government, which was to be effective till end-june, but was extended till end-august, may also have been a factor that contributed to the increase in market activity during this period. Table 12.7 Share Market Indicators End 2002 End September 2003 ASPI - end period (1985=100) MPI - end period (1998 Dec. =1000) 1, ,394.8 Turnover (Rs. mn)* 30, ,911.0 Net Foreign Purchases (Rs. mn)* 2, Market Capitalisation (Rs. bn) * Cumulative Source: Colombo Stock Exchange The All Share Price Index (ASPI) and the Milanka Price Index (MPI) increased by 58.6 per cent and 74.2 per cent, respectively while the market capitalisation and the market price earnings ratio increased by 89.5 per cent and 13.2 per cent, respectively during the first 9 months in The highest monthly turnover, thus far, (Rs.16.5 billion) was in September The highest daily turnover to be recorded on the CSE of Rs.4.88 billion, was recorded on 19 September 2003; prior to this the highest daily turnover was Rs.867 million, on 10 December A new development in the stock market was the opening of a fully-fledged branch office of the Colombo Stock Exchange (CSE) in Kandy on 4 June 2003, with the participation of six broker companies. The CSE has been successfully operating a branch in Matara since Later this year, CSE plans to launch a debt securities board (DEX), which will facilitate scripless trading in government securities as well as other debt instruments. Expected Developments in 2004 Based on the projections of economic growth of about 6 per cent and inflation of about 5-6 per cent (a higher incrrease of about 7 percent is projected for GDP deffector reflecting the potential impact from wage increases), the desirable growth in money supply in 2004 has been projected at 13.5 per cent which is compatible with the overall macro-economic framework to facilitate the declining trend in inflation and support the expected economic growth. The main emphasis of the monetary programme has been on permitting a greater flow of resources to the more efficient private sector, which would enhance domestic investment. With a reduced overall deficit of the government, an increase in the receipt of foreign funding and reforms in public enterprises, a substantial reduction in public sector domestic credit demand (both the government and the public corporations) is expected. This fiscal consolidation is critical to achieve the expected monetary targets. The growth in reserve money will be maintained at around the growth of money supply with the expected stability in the money multiplier. The Central Bank will issue its own securities for liquidity management, in the absence of government securities in its portfolio. Interest rates are likely to ease further in 2004, as and inflationary pressure is expected to be 77

11 lower, the fiscal outlook and balance of payments surplus are expected to improve. With share prices picking up, private sector companies seeking fresh capital are likely to obtain listing on the CSE. By adding depth to the market, these new issues of shares would increase the ability of the CSE to absorb new investment without undue volatility in share prices, and hence would attract further foreign investment inflows. Debt market activity is expected to expand further, with lower interest rates, improved market liquidity and improvements in market infrastructure. The elongation of government security yield curve with the issue of longer-term government bonds, the implementation of the Real Time Gross Settlement (RTGS) System, and the introduction of a Scripless Securities Settlement System (SSSS) would also help expand debt market activity. However, continuing of reforms are critical to develop the domestic private debt market which is still in an underdeveloped stage. 78