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Economist bets on another round of policy rate hike

25 July 2016 09:00 am - 0     - {{hitsCtrl.values.hits}}

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Still higher private sector credit growth and the rising inflation will put pressure on the Monetary Board to increase the policy rates and it is only a matter of time the new Central Bank Governor settles in before the next policy tightening takes place, an economist said. 


According to Lead Economist and Senior Product Head of Frontier Research, Shiran Fernando, the market is expecting at least another 50 basis points hike in key rates during the third quarter or ahead. 


“We are still on a tightening cycle”, Fernando told a seminar organized by the Ceylon Chamber of Commerce to discuss the economic outlook for Sri Lanka during the second half of 2016, following the Brexit fallout and the International Monetary Fund (IMF) lifeline 
received in June. 


The Monetary Board of the Central Bank meets every month to decide on the suitability of the current monetary policy, based on the trajectory of the inflation and the growth in the private sector credit extended by the banks. 


The July monetary policy is due this week. “Banks are still saying that the credit growth is still quite healthy. We are still not seeing it coming down as expected.


 Inflation is also on the up,” said Fernando, adding that these macro-economic data would trigger another round monetary tightening. 


Meanwhile, the Chief Operating Officer and Head of Research at Softlogic Stockbrokers, Danushka Samarasinghe believes the interest rates have nearly peaked now but the inflation is a cause 
for concern. 


Fernando added that the markets had already factored in the impending rate hike as seen from the narrowing spreads between the key policy rates and 


bond yields. Sri Lanka left its Standing Deposit Facility Rate (SDFR) and the Standing Lending Facility Rate (SLFR) unchanged at 6.50 percent and 8.50 percent for the fourth straight month in June after raising the rates by 50 basis points in February. 


However, the private sector credit has been strong – growing above 25 percent year-on-year every month and core-inflation at 6.4 percent in June – slightly down from 6.6 percent in May. But the Central Bank is of the belief that the earlier tightening measures – increase in banks’ statutory reserve ratio and the policy rate hike – take time to adjust the markets as the there is generally a 12 to 18 months of lag between the monetary policy action and its effects to take hold. 


“ So, if you see the historical trends, it still has about 9 to 10 months to run before we see the full effects of the changes that were made,” the newly appointed Central Bank Governor, Dr. Indrajith Coomaraswamy said soon after taking office earlier this month. 

Any further hike in key policy rates will make the government treasuries attractive for foreigners because the hike in United States treasuries is further delayed due to global uncertainties. 
This will not just cushion the domestic money market liquidity but also will buttress the rupee from getting exposed to further pressure. 


However, Fernando said any rate increase by the Central Bank should not crush the private credit demand as it takes a long 15 to 18 months for private credit to recover as seen in past cycles. 
Private sector credit is the linchpin in driving an economy through consumption and investments. But it also creates inflation, currency instability and balance of payment crises if not handled carefully. Therefore private credit is considered a Central Bankers’ nightmare.  

 

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