Macro Analysis /

Sri Lanka Monetary Policy Review: July 2019

    Lakshini Fernando
    Asia Securities
    12 July 2019
    Published by

    The fourth MPR by the CB was held yesterday, with rates remaining unchanged, in line with our expectations. As such, SDFR stands at 7.50%, and SLFR at 8.50%. Our key takeaways are: 1) full impact of monetary policy changes yet to be reflected in the economy, 2) credit growth hits 3-year low on low consumer sentiment, and 3) inflation expected to remain stable on slowing aggregate demand. We maintain our GDP growth forecast of 2.5% for CY19E and 3.8% for CY20E. We revise our currency forecast on lower pressure on the currency from muted credit growth and low import demand. As such we revise our estimate from USD/LKR 185.00 to USD/LKR 179.00 for CY19E (2.1% YoY appereciation) and USD/LKR 183.40 for CY20E (2.5% depreciation).

    Rates left unchanged; lag effect of policies to materialize towards 4Q CY19E. Key policy rates were left unchanged, in-line with our expectations. The loose monetary policy stance taken in May 2019 combined with liquidity injections from a lower SRR have resulted in 1) bank deposit rates dropping by over 100bps, 2) AWPLR declining by 79bps YTD and 3) bond yields marking a 229bps YTD. Meanwhile, average overnight repo rates were down by 61bps MoM, while overnight excess liquidity was at LKR 27bn, down by c19.7% MoM. In our view, the lag effect of monetary policy changes implemented in the past months is yet to take its full effect. We expect the multiplier effect to materialize at a slow pace towards 4Q CY19E.

    Credit growth continues to decelerate; uptick expected in 3Q CY19E. Private sector credit growth continued to decelerate for the fifth straight month, recording a 9.2% YoY growth in May, the lowest levels recorded over the past three years. SoE credit growth declined to 19.4% YoY (+24.9% YoY in April) also indicating a slowdown in public sector loan demand. We expect credit growth to pick up modestly in 3Q CY19E with improved business sentiment. However, we don’t expect a significant pickup for the remainder of the year, 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) CY19E growth to come in at 2.5% YoY on slow recovery – We maintain our expectation of a consumer-led growth in 2H CY19E on the back of a bumper paddy harvest in 1H CY19 adding impetus to farmer incomes. We also expect govt concessions such as the public sector salary hike in July and the extension to a special drawing facility for pensioners to positively impact consumer spending. On the negative, the slowdown in tourism-related sectors combined with low investor confidence, in our view, will dampen growth for the remainder of the year.

    2) Currency to record an appreciation of 2.1% in CY19E – The USD/LKR has recorded a 4.1% appreciation YTD (c11.0% dep’n YoY). 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. We also expect the sharp depreciation seen during the latter half of 2018 to correct itself, thereby recording an appreciation in CY19E. However, we do expect further outflows, especially in the Government bond market albeit to a smaller extent towards the end of the year. Taking the above into consideration, we revise our currency forecast from LKR 185.00 to LKR 179.00 for 2019. We forecast the USD/LKR at 183.40 for 2020 (2.5% dep’n) and LKR 189.00 for 2021 (3.1% dep’n).