At the first Monetary Policy Meeting for 2022, the Central Bank (CB) increased its key policy rates, in-line with our view. The 50bps rate hike came in higher than our expectation of 25bps owing to the CB’s view of curtailing excess demand pressure. SDFR currently stands at 5.50%, and SLFR at 6.50%. The SLFR remains lower than 1-year Government bond yields which are at 8.48%. Our key takeaways are: 1) further rate hikes likely in 2022, 2) food inflation continues to be a near-term concern and 3) negative real rates to persist in the short term. We expect 2022 GDP to grow at 3.8% - 4.0% YoY. With the wide variance between official and parallel market exchange rates, we factor in a correction to the USD/LKR in 2022. As such, we forecast the USD/LKR at 245.00 – 250.00 by year end. Our key concerns at this point are 1) low room for fiscal assistance to support growth, 2) the absence of a medium-term policy framework for the government’s revenue generating policies and 3) elevated global commodity prices.
CB increases rates by 50bps; expects 2021 GDP to of 4.0% YoY
The CB increased key policy rates by 50bps to curb excessive demand pressure in the economy. Meanwhile, the weekly average AWPLR has remained unchanged in January so far compared with December, while the AWPLR increased 2.53pp since January 2021 (currently at 8.26%) amidst an overnight liquidity shortage of LKR 338bn. 1-year bond yields picked up to some extent during the month, now at 8.48% in the primary market, from 8.44% previously. However, preference for short term borrowing was evident, with the 3-mth yield at 8.49 resulting in an inverted yield curve (6-mth at 8.44%). Notably, CB holdings of government securities remained high, at LKR 1.5tn. However, given that the SLR (6.50%) is lower than 3-mth yields, an arbitrage opportunity remains in the market. Meanwhile, the CB expects 2021 growth to come in at 4.0% YoY, marginally below our forecast of 4.2% YoY.
Private credit remains positive; we forecast at 12.0% - 14.0% YoY in 2022
Private sector credit grew at a relatively slower pace of 0.9% MoM (+13.5% YoY) in November. SoE credit growth eased in November, shrinking by 0.8% MoM (+17.2% YoY). Looking ahead, we forecast private sector credit growth at 12.0% - 14.0% YoY for 2022 on the back of higher demand for short term credit. However, the government’s domestic refinancing requirement may crowd up private sector credit growth to some extent.
Reserves at USD 3.1bn; Swap inflows a near term positive
Official reserves increased to USD 3.1bn in December, up 97.7% MoM (-44.6% YoY). According to CB data, USD 171mn repayments (only foreign currency loans, securities, and deposits) were due during the month. CB expects reserves to improve owing to measures undertaken to attract fresh forex inflows including those targeted at attracting remittances into official channels. We expect the CB to depend on swaps and Govt to Govt lending in the near term. A key factor is non-debt inflows to support reserves. While we note that discussions are underway to finalise a number of swaps, bilateral loans and sale of state assets, timing of these inflows is key. Meanwhile, the pickup in tourism is a key positive.