Macro Analysis /
Sri Lanka

Sri Lanka: Rates on hold, but policy loosening likely in 1Q 20

    Asia Securities
    28 December 2019
    Published byAsia Securities

    Sri Lanka's central bank held its final monetary policy review for 2019 yesterday, at which the SDFR and SLFR were left unchanged, in-line with our expectations. SDFR now stands at 7.00%, and SLFR at 8.00%. 

    Our key takeaways are:

    1. High probability of a rate cut in 1Q 2020, 
    2. Credit growth to pick up gradually by 1Q 2020, 
    3. Fiscal loosening to help boost growth and 4) adverse weather conditions to negatively impact food inflation. 

    We maintain our GDP growth forecast of 2.5% for 2019 and 4.0% for 2020. We maintain our currency forecast of USD/LKR 181.00 for 2019 (1.0% YoY appreciation) and USD/LKR 189.00 for 2020 (4.4% depreciation). We view the loose fiscal policy measures taken by the government as a short-term positive for GDP growth and overall consumer sentiment. However: 1) the govt’s revenue-generating policies; and 2) a borrowing requirement of cUSD 3.0bn per year from 2020-24 are concerns for the medium term.

    Rates remain unchanged amidst fiscal loosening

    Key policy rates were left unchanged following the 50bps cut in August. The loose monetary policy stance taken so far this year, combined with liquidity injections from a lower SRR have resulted in 1) weekly AWPLR declining by ~183bps YTD and 2) bond yields shaving off ~240bps YTD (~263bps in November). Meanwhile, average overnight repo rates were marginally down from 7.53% in October to 7.50% in December, while overnight excess liquidity averaged at LKR 21bn so far in December, up ~62.4% MoM. The Central Bank expects AWPLR to reduce by a further 70bps to reach 9.50% by year end (currently at 10.11%). In our view, however, we expect AWPLR to end marginally higher, at ~10.00%. We expect the lending caps implemented by the Central Bank to also impact credit growth positively going into 2020, albeit at a slower pace than required.

    Credit growth continues to decelerate; uptick expected towards 1Q 2020

    Private sector credit continued to decelerate, recording a 4.4% YoY growth in November (+5.1% in Oct), the lowest levels recorded over the past three years. SoE credit growth also decelerated to 12.2% YoY (+12.5% YoY in Oct) and remained below its 5-month average of 14.2%. We expect credit growth to pick up towards early 2020 on the back of lower interest rates and looser fiscal policy, combined with improved business sentiment. While we forecast private sector credit growth to come in at ~5.5%-6.0% YoY in 2019 we acknowledge that this may end the year marginally lower than our forecast. We expect this to pick up to ~15.0%-18.0% in 2020.

    Inflation to remain stable; adverse weather a concern

    The CB expects inflation to remain within the 4.0%-6.0% range in 2019, in-line with our expectation. We expect a negative impact on food prices owing to the drought followed by above-average rainfall experienced in some provinces (which is evident with higher food inflation in recent months). Our channel checks confirm that the floods have resulted in early harvests and delays in cultivation. We expect a normalisation of food inflation in 2020.