At the first Monetary Policy meeting under the newly appointed Governor, Dr. Nandalal Weerasinghe, the Central Bank (CB) showed its strong Monetary stance by increasing its key policy rates by 700bps, above our expectations. This is one of the sharpest single increases by the CBSL to date. Following this, SDFR currently stands at 13.50%, and SLFR at 14.50%. This has taken off the arbitrage opportunity seen in the market for the past months, where the 1-year Government bond yield was significantly higher than the SLR. Our key takeaways are: 1) confirmation of ongoing technical discussions with the IMF, together with restructuring plans currently underway, 2) further rate hikes unlikely in the near term, 3) potential easing of the mandatory 50% sale of remittance inflows by banks to the CB likely, 4) inflation to spike up further in the near term but, to taper down towards year end, 5) improving political and social stability a key requirement to sustain stability. We expect 2022 GDP to contract by 2.0% - 3.0% YoY. Our key concerns at this point are 1) growth impact from concerningly low forex reserves, 2) low room for fiscal assistance to support growth, 3) the absence of a medium-term policy framework for the government’s revenue generating policies and 3) elevated global commodity prices which could be further exacerbated by geopolitical tensions in Eastern Europe. A key positive is that today’s monetary policy stance indicates that the CB looks to act proactively and independently going forward.
CB increases rates by 700bps to address inflationary pressure; Emphasises independent and proactive policy stance
The much-awaited monetary policy meeting under the newly appointed Governor showed the CB’s seriousness of implementing a corrective policy stance. As such, the CB increased key policy rates by 700bps as global and local pressure heightened since the last MPR meeting. This comes ahead of the country’s talks with the IMF for a lending agreement. The Governor also stated that current interest rate caps on lending products (credit cards for example) will be taken off in the coming days. He also indicated potential relaxing of the mandatory 50% sale of remittance inflows by banks to the CB, which will help ease Dollar liquidity pressure for banks, and help ease the blocks of opening LCs for essential imports. A key positive was the Governor’s comments of striving towards greater transparency, credibility and proactive measures from the CB, a much-needed change in policy stance against the current backdrop. Ahead of the policy meeting, the weekly average AWPLR has increased approx. 4.00pp since January 2021 (currently at 9.85%) amidst an overnight liquidity shortage of LKR 587bn. 1-year bond yields picked up sharply at the last auction, now at 15.69% (12.28% at the previous auction). Notably, CB holdings of government securities remained high, at LKR 1.8tn. A key positive is that the SLR (14.50%) is higher than 3-mth yields (14.12%), removing the arbitrage opportunity which was in the market previously.
Debt restructuring process at play; proposals for legal and financial advisors expected to be closed within a week
The Governor announced that the CB is currently in the process of obtaining proposals for legal and financial advisors for debt restructuring, with the entire process expected to take about 2 weeks to finalise. Meanwhile, talks for technical advice and a potential policy package with the IMF is expected to take place parallelly. This emphasises the sense of urgency for corrective policy measures by the CB at this point. Meanwhile, the Ministry of Finance is expected to announce a policy outline to stabilize the economy, which is expected to be presented to parliament in the near term.
Private credit demand looks to taper down with rate hike
Private sector credit grew at a relatively slower pace of 0.9% MoM (+13.1% YoY) in December, the latest data available. SoE credit growth continued its upward trend in December, up 0.3% MoM (+18.5% YoY). Looking ahead, with the sharp increase in policy rates, and the overall macro uncertainty, we factor in a lower credit demand. We note that the govt’s domestic refinancing requirement may crowd up private sector credit growth to some extent.