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Credit card interest rate hike: A painful solution to the crisis

8 months ago

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  • Inflation-induced downward spiral has begun
  • Political stability and economic reforms needed
By Vinu Opanayake  The annual interest rates imposed on local credit cards were recently increased to 36%. Yes, you read that right – 36% per annum. Economists opine that the move will be a hit to the already-struggling banking sector, while also negatively impacting customer expenditure.  According to the University of Colombo Department of Arts Faculty of Economics Senior Lecturer and Attorney-at-Law Dr. Shanuka Senarath, the impact of this move on the vulnerable segments of society will be somewhat negligible.  “Many people in Sri Lanka don’t use credit cards. Not even 2% of those who are in poverty would be using credit cards, so it is safe to assume they are out of this picture. However, this move to increase rates will still affect the banking system and the public in a different way,” Dr. Senarath stated, adding that the higher rates may force a drop in credit card usage and spur consumers to use cash for purchases of goods and services. Economy shrinking Dr. Senarath pointed out that the macro economy, which had shrunk by over 20%, was continuing to shrink and that the financial economy too would shrink, as along with the interest rate hike on credit cards, the consumption economy would shrink, which he said was certainly ‘not a good thing’. “With prices going up, not many people are buying certain things in the market; this is called a downward spiral and it has already started. Increasing interest rate charges have certainly contributed to that,” he added. He stated that banks were increasing charges in order to make profits but they were in fact losing their market. However, he added that he understood that there was no option but to increase charges because banks were also suffering.  “Even to use a credit card, you need a decent level of income. This will definitely impact the banking sector, because it is also shrinking. This means we will be facing bankruptcy. Higher interest charges are a sign that we are heading towards a severely shrinking economy,” he explained. Further, he noted that with an economic recession, there was nothing the authorities could do to contain interest rate hikes. Dr. Senarath explained that political stability was a prerequisite for fixing the macroeconomic challenges Sri Lanka was facing, adding that the International Monetary Fund (IMF) would only assist if such conditions were met.  He also stressed on the importance of securing IMF assistance and reviving the economy, as without such steps, cutting interest rates and working on poverty alleviation would be out of reach. Global outlook The IMF is pushing central banks worldwide to raise interest rates, warning that the global economy is nearing a recession. It has forecast the economy to slow down to 3.2% in 2022 and 2.9% in 2023, with major economies such as the US, China, and Europe stalling. In the July update of the IMF’s World Economic Outlook, IMF Chief Economist Pierre-Olivier Gourinchas said that higher-than-expected inflation, especially in the US and major European economies, was triggering a tightening of global financial conditions.  He said that China’s slowdown has been worse than anticipated amid Covid-19 outbreaks and lockdowns and there had been further negative spillovers from the war in Ukraine. Severe impact on cardholders Meanwhile, expressing his thoughts on the interest rate hike on credit cards, Advocata Institute Chief Operating Officer Dhananath Fernando told The Sunday Morning that with the increase, credit cardholders would be impacted severely because their capacity to repay the money would be reduced.  “When someone is unable to pay, they will be transferred to the Credit Information Bureau (CRIB) and it has negative consequences on their eligibility to borrow in the future. On the other hand, defaulted credit cards are recorded as Non-Performing Loans (NPLs) and it is a hit on banks,” Fernando stated. However, he stated that this did not mean the rates on credit cards should be brought down as they were being increased to discourage the public from spending excessively as part of the measures being taken to overcome the prevailing economic crisis. “When there is more money available, people will be spending more on imported items and we do not have dollars to import, therefore this move cuts down the demand. All these moves we are taking to overcome the economic crisis have their own repercussions that we cannot avoid. If we take the interest rate, of course people will get affected, but you also cannot keep it low because you will run out of dollars to import. This is a challenge,” he explained.  Economic reforms needed According to Fernando, during these difficult times, one cannot avoid these impacts but can minimise the time period of the impacts, which requires economic reforms. “Deep structural issues of the economy need to be addressed. We have to make sure the currency is stable and the Central Bank is independent, because attempting to fix these issues without addressing the fundamental macroeconomic issues is like colour washing a house that requires deep structural changes,” Fernando stated.  According to statistics published in the Central Bank of Sri Lanka (CBSL) Payments Bulletin for Q3 of 2021, a total number of 62,855 new credit cards were issued during the quarter, through which Rs. 12 million had been transacted.   Furthermore, a total number of 2,071,348 cards were in use during Q3 2021, which is an increase from 1,981,285 in Q3 2020.   However, CBSL data reveals as of Q3 2021, a total number of 175,152 credit cards had defaulted, amounting to approximately Rs. 16.4 billion in value.  

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