Macro Analysis /
Global

Sri Lanka: Monetary Policy Review November 2021 – Key policy rates unchanged

  • CB maintains rates. Government bond yields ease marginally but, arbitrage opportunity remains

  • Private credit remains positive; we forecast at 14.0% - 16.0% YoY in 2021

  • Outlook

Lakshini Fernando
Asia Securities
25 November 2021
Published by

At the final Monetary Policy Meeting for 2021, the Central Bank (CB) maintained its key policy rates, following the 50bps hike in August. SDFR currently stands at 5.00%, and SLFR at 6.00%. With the SLFR lower than 1-year Government bond yields which are at 8.16%, the arbitrage opportunity in the market continues. Our key takeaways are: 1) food inflation continued to be a near-term concern, 2) market interest rates to remain in single digit levels in early 2022, and 3) negative real rates to persist in the short term. We expect 2021 GDP to grow at 4.2% - 4.4% YoY. 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 maintains rates. Government bond yields ease marginally but, arbitrage opportunity remains

Against our expectations of a 25bps hike, the CB maintained key policy rates at current levels, following the 50bps hike in August stating that the current measures taken are sufficient to curb excessive demand pressure. Meanwhile, the weekly average AWPLR has increased 0.94pp MoM in October, while the AWPLR declined 2.35pp since January 2020 (currently at 7.76%) amidst an overnight liquidity shortage of LKR 199bn. 1-year bond yields eased to some extent during the month, now at 8.16% in the primary market, from 8.17% previously. (3-mth at 7.53% and 6-mth at 8.02%). Notably, CB holdings of government securities remained high, at LKR 1.4tn. However, given that the SLR (6.00%) is lower than 1-year yields, an arbitrage opportunity remains in the market.

Private credit remains positive; we forecast at 14.0% - 16.0% YoY in 2021

Private sector credit grew at a relatively slower pace of 0.4% MoM (+13.8% YoY) in September, outpacing public lending. SoE credit growth continued to ease, shrinking by -1.2% MoM (+10.3% YoY). Looking ahead, we forecast private sector credit growth at 14.0% - 16.0% YoY for 2021 on the back of higher demand for short term credit, and 12.00% in 2022. However, the government’s domestic refinancing requirement may crowd up private sector credit growth to some extent.

Outlook

  1. We maintain our growth forecast of 4.4% YoY for 2021 - With the easing of restrictions and the ongoing vaccination drive, we expect the overall economy to grow by 4.2% - 4.4% YoY in 2021. A resumption of tourism is a key positive at this point.

  2. Currency pressure on low inflows - With low USD liquidity, we expect the USD/LKR to face higher pressure towards 2H 2021. We forecast the USD/LKR at 210.00 – 215.00 in 2021. We note that attracting non-debt related FDIs is key.

  3. Fiscal deficit to widen in 2021 - We expect pressure on the fiscal deficit amidst a low revenue collection cycle. We forecast the deficit to reach 11.3% of GDP in 2021.