The monetary board would continue the policy rates with no change, considering the fact that it is too early to assess the impact of the previous 50bps rate cut, First Capital Research said in a report.
“We believe that Monetary Board may first consider, CBSL’s ability to implement lending rate caps before further policy rate cuts being implemented. However, considering the slowness of the economy and the contraction of credit, we would not rule out a further 25bps rate cut towards 4Q2019, if economic growth fails to accelerate,” according to Pre-Policy Analysis by First Capital.
A sustained positive liquidity position was maintained resulting from multiple SRR cuts in Nov 2018 and Mar 2019 and due to release of long-delayed payments by the government. Net Contraction in credit during Jan-Apr 2019 period is likely to have also supported the improvement in liquidity. Considering the period within which a policy rate cut was implemented, we believe it may take a lengthier period for lending rates in the market to decline and stimulate growth.
The high level of NPL in the system may delay the dip in lending rates. However, in order to accelerate the reduction in lending rates, as previously indicated by the CBSL, we expect imposition of a cap on lending rates to enhance credit flows to the economy with the intention of boosting the economic and credit growth.
The report added, “In line with our expectation of an “inevitable rate cut”, CBSL reduced the SLFR and SDFR by 50bps as they believed, policy intervention was required to address the subpar economic growth which was further affected by the Easter Sunday attacks.”
“Sri Lanka maintained foreign reserve position at USD 6.7Bn as at 31st May 2019 which is noteworthy considering the major outflows in Apr 2019. Furthermore, SL successfully raised USD 2.0Bn by conducting an International Sovereign Bond offering tenors of 5 and 10 year. Following the issuance, we expect the foreign reserves to show significant improvement reaching above USD 8.0Bn in Jun 2019 while maintaining above USD 7.5Bn during Jul to Dec 2019. Cabinet approval was obtained to raise up to LKR 480.0Bn for debt management through liability management act, which provides leeway for CBSL to raise further USD 2.5Bn as indicated to manage debt in 2020, which would be a year with multiple elections. Sri Lanka’s next international sovereign repayment is only due in Oct 2020 amounting to USD 1.0Bn while 1Q and 2Q each constitute USD 0.4Bn of SLDBs maturing. Raising funds well in advance for repayments is expected to significantly strengthen macro economic outlook for Sri Lanka and to reduce unnecessary volatility.”
LKR remained stable to close at 176.42 on 28th Jun 2019 supported by foreign inflows, exporter conversions and contraction in imports. However, REER (2017=100) continued to remain undervalued at 91.95 in May 2019 while we estimate it to be 92.35 in Jun 2019.
The external environment is favoring lower yields as the weakening US economy led the Fed to rethink its interest rate normalization strategy resulting in Fed indicating a likely monetary easing in upcoming meetings. The situation has weakened the dollar further supporting the stability of rupee.