25 November 2020 08:20 am
First Capital Research (FCR) expects the Central Bank (CB) to maintain the current policy rates unchanged at the monetary policy review tomorrow amid recent improvements in private sector credit, rock bottom market interest rates and excess liquidity in the system, while retaining the monetary policy stance at “accommodative”.
However, the Colombo-based research house in its latest pre-policy analysis report maintained a 50 percent probability for a rate cut to boost lackluster economic growth.
“We believe that there is a 50 percent probability to hold rates due to improvement in high frequency indicators. Moreover, there is a 25 percent probability for 25bps and 50 bps (rate cut) respectively to support economic growth,” it stated. The CB is scheduled to announce the monetary policy review at 7.30 a.m. tomorrow.
As a result of various measures taken by the government and the CB including multiple policy rate cuts during the year, private sector credit saw a marked improvement to Rs.87.4 billion in September while the market liquidity reached Rs.140 billion as of November 13, indicating surplus liquidity in the system.
Further, recent key economic indicators, such as unemployment rate suggest that economic activity has remained steady without much deterioration in the second quarter despite the impact of COVID-19 outbreak in the quarter.
The unemployment rate declined to 5.4 percent in the second quarter from 5.7 percent in the first quarter.
However, the Department of Census and Statistics has delayed the release of GDP estimates for the second quarter until next month.
FCR estimated that Sri Lanka’s GDP would see its steepest contraction in history at 5.8 percent in 2020 following the unexpected contraction of 1.6 percent in the first quarter.
The CB has also extended the debt moratorium for another six months period, which was to expire at the end of September, considering the challenges faced by businesses and individuals due to the second wave of COVID-19.
In addition, both market deposits and lending rates have come down significantly in response to previous monetary easing measures implemented by the CB to bring down borrowing cost.
FCR opined that these factors would argue against further easing in monetary policy at the review tomorrow.
“We believe that considering the recovery in private credit and historic low levels in AWPR, there is no vital requirement for CBSL to provide a rate cut and to further bring down the market lending rates drastically,” it said.
However, the CB might be pressured to cut policy rates further to ensure low cost financing for the government as it now relies more on domestic funding to finance the budget deficit.
“In the midst of limited access to international financial markets, the government opts to rely more on domestic borrowings to finance the budget deficit and hence easing rates at the upcoming policy meeting results in reduced funding cost favouring the government,” FCR said.
According to the government’s latest mid-term fiscal management strategy, it plans to increase domestic borrowing to 9.3 percent of GDP in 2021 compared to the estimated 6 percent this year.
Domestic to foreign debt ratio as of end-July had already risen to 54:46 compared to 51:49 as at 2019 end.
Prime Minister Mahinda Rajapaksa in his budget speech last week called on the CB to adopt new perspective on the monetary policy regarding money and liquidity management.
FCR also noted that a policy rate cut would become a sweetener to sustain the yields at current low levels and to enhance activities of the secondary bond market.
Despite the improved liquidity position, yields in the secondary market recently witnessed a slight increase with low activities as market participants followed a wait and see approach amidst the looming uncertainty. (NF)