Sri Lanka: Monetary Policy Review May 2021 - Rates remain unchanged

  • CB maintains rates; growth momentum to slow down in 2Q 2021
  • Private credit grows; we forecast at 10.0% - 12.0% YoY in 2021
  • Inflation to record a gradual increase in 2021

In-line with our expectations, the Central Bank (CB) maintained key policy rates at the current level, following its monetary policy meeting yesterday. This came amidst the CB reiterating its stance of maintaining a low stable interest rate environment to support growth momentum amidst the third wave of COVID-19 cases. SDFR currently stands at 4.50%, and SLFR at 5.50%. Our key takeaways are: 1) near term impact on growth momentum, 2) market interest rates to remain in single digit levels in 2021 and 3) inflation to gradually pick up. We revise our 2021 GDP growth forecast to 4.8% YoY (5.2% previously) amidst a slower growth forecast in 2Q 2021. Our key concerns at this point are 1) low room for fiscal assistance amidst the third wave, 2) the absence of a medium-term policy framework for the government’s revenue generating policies and 3) negative impact on tourism and exports owing to the third wave.

CB maintains rates; growth momentum to slow down in 2Q 2021

The CB maintained key policy rates yesterday, in-line with our expectations. While leading indicators direct to a recovery in 1Q 2021 (PMI averaging 62 points in 1Q, Confidence index at triple digit levels, mobility data indicating higher economic activity), we expect the current restrictions imposed to stop the spread of COVID-19 to dampen momentum in the near term. This also highlights the need for continued support on both monetary and fiscal fronts in the coming months. Meanwhile, the weekly average AWPLR has declined 438bps since January 2020, while the AWPLR recorded a marginal pickup of 0.11pp in May (currently at 5.73%) despite continued excess liquidity in the market. Meanwhile, 1-year bond yields have picked up marginally to 5.18% in the primary market, from 5.11% in April. Overnight excess liquidity averaged LKR 141bn in May, up 21.3% MoM. Notably, excess liquidity declined 52.0% in early April, amidst likely payment requirements by banks on 31st March.

Private credit grows; we forecast at 10.0% - 12.0% YoY in 2021

Private sector credit continued to grow in March, with MoM credit growing 1.8% (+7.5% YoY). SoE credit growth remained high, at 26.5% YoY (+1.7% MoM) indicating increased financing needs of the government. The CB expects higher lending towards the Micro, Small and Medium scale enterprise sectors to continue. Looking ahead, with low interest rates and high excess liquidity, we forecast credit growth at 10.0% - 12.0% YoY for 2021. However, the government’s domestic refinancing requirement may crowd up private sector credit growth to some extent. We note that our forecasts may be revised downwards to 8.0% - 10.0% in the event of a prolonged impact from the third wave.

Inflation to record a gradual increase in 2021

We expect demand to continue its gradual pick up as seen in recent months, as economic activity picks up. We also factor in higher global oil prices (+29.8% YTD) which will impact the non-food basket. In our view, inflation will remain within the CB threshold of 4.0% - 6.0% YoY in 2021 in the absence of an impact from adverse weather conditions.

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