The first MPR for 2020 by the CB was held today, where the SDFR and SLFR were cut, broadly in-line with our expectations of a rate cut in 1Q CY20. However, the 50bps rate cut came above our forecast of 25bps owing to the slow economic growth momentum. SDFR now stands at 6.50%, and SLFR at 7.50%. Our key takeaways are: 1) credit growth to pick up gradually by 1Q 2020, 2) fiscal loosening to help boost growth, 3) headline inflation to breach CB’s target range in 2020 and 4) no further rate cut expected in 2020. We maintain our GDP growth forecast of 4.0% for 2020 and 4.4% YoY for 2021. We maintain our currency forecast of USD/LKR 189.00 for 2020 (4.3% depreciation) and USD/LKR 195.00 for 2021. We view the loose fiscal policy measures taken by the government as a short term positive for GDP growth and overall consumer sentiment. However, concerns of 1) the govt’s revenue-generating policies and 2) borrowing requirement of ~USD 3.0bn per year from 2020-2024 are concerns for the medium term.
Rates loosened amidst concerns of slow growth in 2020
Key policy rates were cut by 50bps yesterday, above our expectation of a 25bps rate cut. In our view, the 1) higher than forecasted AWPLR in 2019, 2) slower than anticipated 4Q 2019 growth, 3) and the overall global slowdown were the key reasons for the rate cut. The loose monetary policy stance taken in 2019, combined with liquidity injections from a lower SRR have resulted in 1) weekly AWPLR declining by ~225bps since Jan 2019 and 2) bond yields shaving off ~259bps since Jan 2019, but have since picked up by ~24bps MoM (275bps down for 2019). Meanwhile, average overnight repo rates were marginally down from 7.52% in December 2019 to 7.49% in January, while overnight excess liquidity averaged at LKR 32bn so far in January, up ~25.9% MoM. The weekly AWPLR currently stands at 9.62%, above the CB’s 2019 target of 9.50%.
Credit growth shows a marginal uptick in December
Private sector credit recorded a 4.5% YoY growth in 2019 (4.4% YoY in November), below our forecast of 5.5% YoY. This remains to be at the lowest levels recorded over the past three years. SoE credit growth decelerated to 8.3% YoY (+12.2% YoY in Nov) and remained below its 5-month average of 13.0%. We expect credit growth to pick up in 1Q 2020 on the back of lower interest rates and looser fiscal policy, combined with improved business sentiment. As such, we forecast private sector credit growth to come in at ~15.0%-18.0% in 2020.
Inflation to pick up on demand pull and cost push inflation
The CB expects inflation to be over 5.0% in 2020, in-line with our expectations. We expect a negative impact on food prices owing to supply-side constraints to negatively impact inflation in early 2020. However, we factor in higher demand-pull inflation to drive up overall inflation to 6.2% YoY in 2020. We expect a normalisation of food inflation by mid-2020 barring any adverse weather conditions.