Central Bank could leave rates unchanged at upcoming meeting - FCR

• Cites economy is already responding at desired levels to outsize cut in November
• Cautiones further cuts could lead to excesses in areas of hard-won external sector stability ahead of reopening imports for vehicles  

Despite the current stretch of deflation offers some space for the Central Bank to follow through another rate cut at its upcoming meeting this week, there is a bigger chance for the rate setting committee to stay the monetary policy at the current level. 

This is given the sizable cut in the policy rate back in last November, when it set the overnight policy rate (OPR) at 8.00 percent, First Capital Research (FCR) said.

Releasing the customary pre-policy analysis just days ahead of the policy meeting, the first for the year, FCR assigned an 80 percent probability for the Monetary Policy Board to leave its newly introduced OPR at its current level, considering the developments in the broader economy, which is responding to the eased monetary policy.

It also expects the banks’ reserve ratio to be left at its current 2.0 percent level.  

FCR cited the economy, which is firing on almost all cylinders, as evidenced by the continuously improving Purchasing Managers’ Index data for manufacturing, services and construction. This was further supported by the robust economic growth of 5.5 percent in the third quarter.

Both estimates and anecdotal evidence suggest that the economy to have done even better in the final three months of last year, supported by lower rates, post-election euphoria and also the year-end festive demand amid the deflationary conditions.

FCR also highlighted the pick-up in the demand for private credit, which reached just shy of Rs.100.0 billion in November 2024 and the comfortably high level of money market liquidity conditions as further reasons for the rate setting committee to hold off from cutting rates further. The near five-year high business confidence at present will also prove the members of the Monetary Policy Board that the current policy stance is just about the right level, which will neither overheat nor slow the economy. The Central Bank in a recent report on its prolonged departure from its quarterly inflation target said it expects the current stretch of negative annual prices to end in the second quarter of this year, before converging to its 5.0 percent target by the third. The consumer price indices showed that the monthly food prices are accelerating while the deflationary pressures are gradually dissipating from the non-food prices in recent months.

However, the recent cuts to the electricity tariffs by an average of 20 percent could further aid the prices to remain at subdued levels.

FCR cautioned against further easing in monetary policy, which could undermine the gains made in the external sector thus far, given the resumption in the debt repayments post-debt restructuring and rising imports, particularly with the coming reopening of vehicle imports.

This, it said, could weaken the rupee against the dollar and make it difficult for the Central Bank to collect dollars to continue rebuilding foreign currency reserves, which built external sector resilience thus far. Lower borrowing rates stoke demand for credit and thereby the dollars via want for more imports. 

“A stable interest rate policy will help balance the demands of debt repayments, reserve building and import financing without compromising financial and currency stability,” FCR added.