Further monetary easing could be expected towards the second half of 2015 by the Central Bank to stimulate the economic growth as the benign inflation and the slow pick up in private credit provides space for further cuts, according to the research arm of a global bank, which has strong presence in Asia.
Close on the heels of the 50 basis points (bps) rate cut in April 2015 which took the markets by surprise, Standard Chartered Bank (StanChart) expects repetition of the same during the next half of 2015.
“We expect another 50bps reduction in policy rates in H2-2015 amid low inflation and moderating growth,” StanChart said in its Global focus for Q3’2015 titled ‘When perception is not reality’. A few days ago the Central Bank Governor Arjuna Mahendran has told that the interest rates would remain low and are sustainable but would allow the rupee to depreciate under a free floating exchange rate policy with zero intervention in the foreign exchange market.
Meanwhile, the global bank also joined the club of agencies which cut Sri Lanka’s growth forecast for 2015 as it revised down the GDP growth to 7 percent from its earlier forecast of 7.8 percent. This is in line with the Central Bank’s growth target for 2015.
The cut in growth outlook is as a result of lower public spending by the government because the government tries to meet its ambitious fiscal deficit target of 4.4 percent of GDP, down from 6 percent in 2014.
“The government’s focus on fiscal consolidation has led to cuts in public investment spending, which are likely to slow growth this year,” StanChart said.
However, StanChart believes the growth will pick up to 7.5 percent in 2016 due to the lag effect of the easing measures feeding through to the real economic activities.
“Rising wages and falling inflation are likely to boost consumers’ purchasing power; construction and infrastructure activity should also provide support,” they said.
Sri Lanka’s post-war economic growth was largely driven by the high level of state led public infrastructure development, which was financed by commercial borrowings.
However, StanChart believes the share of public expenditure will be drastically cut to 4.6 percent of GDP from 5.6 percent.
This however has negative repercussions on the overall investments in the economy, as private investments are low due to lack of clarity on the economic policy by the government and the uncertainty over the date of the Parliamentary election.
The unity government, which came in to power on January 9, 2015, introduced a host of benefits and giveaways through its interim budget including public sector salary increases tax cuts on essential food items in a bid to provide relief to the masses.
StanChart said this would see a shift in expenditure from public investment to recurrent spending (to a ratio of 20:80 in the interim budget from 30:70 in the original budget).
Foreign holding in G-sec falls to lowest in 3yrs
The collapse in government security (G-sec) yields has resulted in significant profit taking by foreign investors who withdrew as much as US $ 150 million since January 2015 from G-sec resulting in the foreign holding in G-sec to lowest levels in 3-years, StanChart said.
This has narrowed the foreign ownership in G-sec market to 10.4 percent, below the 12.5 percent cap set by the government.
This is because the interest rates hovering around near trough levels which do not give any logical reason for the foreigners to hold on to low yielding Sri Lankan G-sec.
“Election-related uncertainty and concerns about fiscal slippage could further accelerate FII outflows,” they further cautioned.
The situation could be further aggravated by the expected rate hike by the United States (US) Federal Reserve, where Asian region’s liquidity will be absorbed by the US treasuries.
Meanwhile, the trade deficit (imports over exports) is also expected to be widened to 3.1 percent of GDP, after narrowing in 2014.
StanChart also believes that the recent wage hikes for public- and private-sector employees could also reduce the Sri Lanka’s export competitiveness because of the increase in input costs.
“Recent currency depreciation has been fueled by FII outflows and the widening trade deficit,” they said.
StanChart expects the rupee depreciation to further continue and forecast USD/LKR at 135 by September and 136 by December 2015.