High interest for lower rates

The government directive to cut lending rates of state banks generates much interest and uncertainty of its impact on the economy and the financial services sector. A low rate regime is imperative to stimulate growth and expansion. In a competitive environment, entrepreneurs would aspire to undertake borrowings for investment at a lower rate. This augurs well for the volume of national investment.
Sri Lanka’s excessive rates are a result of high inflation and government expenditure. However, with 12-month inflation down to 1.4 per cent in October and the exchange rate under control following Central Bank intervention, this coupled with the developmental push of government has made way for allowing interest rates to fall.
A concern would be the timing and level of intervention. Whilst the government directive refers to state banks, private sector institutions too would be compelled to follow suit.
The order would constitute a significant impact on the state banks, as the sudden revision would affect ongoing facilities, returns and even government revenue.
Despite the promise of government intervention through the Central Bank to prevent any incidence of instability, this would necessitate sizeable action by the regulatory body. Private banks are keen to adopt an approach of ‘wait and see.’ Whilst discussions are under way to reduce lending rates to below 12 per cent, private sector institutions cannot afford to bring existing facilities below previous rates, with due respect to profitability and shareholder responsibility. The loan books of private sector lenders contracted in 2009, and the reduction of rates would serve to reverse that trend.
That done, let us anticipate that the borrowing public would invest wisely. Borrowings for the mere purpose of consumption would only fuel inflation. For instance, we must not leave room for the creation of bubbles like we saw with the property and share market. The public could tend to borrow and invest in property, which would artificially push the market to unprecedented heights. But, at a time of trouble, these could collapse and escalate such a crisis as that which occurred in 2008.
An effective process of checks and balances are essential to manage this process. When market mechanisms are prevented from taking effect due to extensive or interventional regulation, the necessary real credit expansion may not be forthcoming to fund the increase in demand. This could cause the financial services sector to resort to various rationing schemes to allocate credit. Therefore, whilst low interest rates could induce the desired high level of investment, it could also impact adversely on available credit. Hence the need for effective management, and that would ideally be a collective process for government think-tanks and the private sector. The rate of investment depends not only on the volume, but also on the productivity of investment. In many developing countries, a growth response in the short-term could become impossible due to bottlenecks in factors of production and regulation. Thus, government together with relevant authority must move to provide necessary incentives in the spheres of production, infrastructure and labour – these are essential to complement a milieu of increased investment.
So the government moves to present opportunity for growth and investment – for public, for entrepreneurship and the nation at large. It is the public’s responsibility to employ opportunity with prudence and maturity – to suffice the greater national need as that of self. Economics is not a place for politics in a developmental thrust, and perhaps the time for policy and action would be post the 2010 election. How will the nation vote, and how shall we invest?