Macro Analysis /
Sri Lanka

Sri Lanka Monetary Policy Review: August – Rates cut to stimulate private sector lending

    Lakshini Fernando
    Asia Securities
    23 August 2019
    Published by

    Sri Lanka's central bank cut rates yesterday at the fifth MPR for 2019, where both the SDFR and SLFR were reduced by 50bps, against our expectations. SDFR now stands at 7.00% and SLFR at 8.00%. Our key takeaways are: 1) rate cut to help boost private sector lending, 2) currency to see some pressure amid outflows, but remain stable, and 3) inflation to remain stable on slowing aggregate demand despite disruption to food supply. We maintain our GDP growth forecast of 2.5% for CY 19e and 3.8% for CY 20e. We maintain our currency forecast of US$/LKR 179.00 for CY 19e (2.1% yoy appreciation) and US$/LKR 183.40 for CY 20e (2.5% depreciation).

    Rates cut on slow private sector lending

    Key policy rates were loosened, against our expectations, by 50bps. The loose monetary policy stance taken in May 2019 combined with liquidity injections from a lower SRR have resulted in 1) AWPLR declining by 100bps YTD and 2) bond yields shaving off c300bps YTD. Meanwhile, average overnight repo rates were marginally up from 7.73% in July to 7.76% in August, while overnight excess liquidity averaged at LKR 26bn, down by ~15.8% MoM. While we believe that the of monetary policy changes implemented previously is yet to take full effect, we expect the current rate cuts to help stimulate lending at a faster pace.

    Credit growth continues to decelerate; uptick expected towards end-19

    Private sector credit growth continued to decelerate for the seventh straight month, recording a 7.7% YoY growth in July (+8.7% in June), the lowest levels recorded over the past three years. SoE credit growth declined to 14.6% YoY (+17.9% YoY in June) also indicating a slowdown in public sector loan demand. In our view, this was a key reason behind the CB taking a loose monetary policy stance, amidst a stable inflationary and currency backdrop. We expect credit growth to pick up modestly towards the end of 2019, with improved business sentiment. However, we do not expect this to be a significant pickup and forecast private sector credit growth to come in at ~5.5%-6.0% YoY by year end.

    Inflation to remain stable; prolonged drought a concern

    The CB expects inflation to remain within the desired 4.0%-6.0% range on lower inflationary pressure as a result of lower demand. We expect a negative impact on food prices owing to the drought conditions experienced in some provinces. While our channel checks confirm that the drought has not had a negative impact on paddy cultivation, the dry weather in the Southern coast and the Eastern province has impacted coconut cultivation. Barring any prolonged adverse weather conditions, we expect inflation to come in at 4.8% YoY in 2019E.


    1) CY 19e growth to come in at 2.5%yoy on slow recovery – We maintain our expectations of consumer-led growth in H2 CY 19e on the back of a bumper paddy harvest in H1 CY 19 adding impetus to farmer incomes. We also expect govt concessions such as the public sector salary hike in July and the favourable pension changes to positively impact spending. On the negative, the slowdown in tourism related sectors and low investor confidence, will dampen growth for the remainder of the year. Lower lending towards agri, industry and services areas in 2Q CY19 in our view will also lead to slower overall growth.

    2) Currency to appreciate 2.1% in CY 19e – The US$/LKR has recorded a 2.4% appreciation YTD (c4.1% YTD in early July). While we expect lower tourism and remittance related inflows to have a negative impact on the currency, slow credit growth combined with slow import demand will help ease pressure on the currency. However, we do expect further outflows, especially in the Government bond market albeit to a smaller extent towards the end of the year. We maintain our currency forecast of USD/LKR 179.00 for 2019, USD/LKR at 183.40 for 2020 (2.5% dep’n) and LKR 189.00 for 2021 (3.1% dep’n).