Continuation of policy rates amidst slow economic activities

Policy rates to continue, amidst slow economic activities and to allow the impact of previous rate hike to materialize.

Previous pre-policy issue

First Capital Research believed that the risk posed by relatively lower reserve position prevailed during the period, foreign debt repayment fell due in 1Q 2019, coupled with sovereign downgrade from three major rating agencies were addressed by the unexpected rate hike in November 2018, while allowing the impact of the rate hike to materialize during 1Q 2019 by improving credit and GDP growth.

Changes took place during period

Instability in political front continued as further delay in holding provincial council elections, major political parties not having nominated their prospective presidential candidate while divergence between the president and United National Front (UNF) continue to persist.

In early January, the secondary market yield curve experienced a parallel downward shift predominantly on the belly and long end of the curve, followed by a brief uptrend with the overall curve dipping by 22-60bps. The equity market saw a continuous downward shift with low activities and foreign outflow of Rs.5.1 billion year-to-date. However, the debt market saw an inflow of Rs.20.5 billion since mid-january 2019. On the back of foreign inflows and accelerated US dollar conversions by exporters, US dollar : Sri Lankan rupee strengthened towards early February 2019, to reach Rs.176.65 on February 1, from 2018 closing of 182.90 and stabilising around 178.00179.00 levels.

The Central Bank of Sri Lanka (CBSL) holdings increased throughout the period to peak at Rs.177.2 billion and stabilized around Rs.176.3 billion while market liquidity shortage widened to Rs.139.3 billion towards midjanuary 2019 and narrowed to fall below Rs.70.0 billion. Fed indicated the adoption of a cautious approach signalling that the tightening phase might be coming to an end amid rising risks to economic growth.

First Capital Research believes that continuation of policy rate is appropriate. However, First Capital Research has increased the biasness towards a rate cut where First Capital Research allocates a 10 percent probability in February 2019. Strategy report recap [policy rate expectation]: On a base case, First Capital Research expects two rate cuts of 25bps each during 2019 (2Q and 4Q) as overnight CBSL standing lending facility rate, which stands at 9.0 percent, First Capital Research believes is too high for accelerated economic activity.

Expected monetary policy stance

Considering the below par GDP growth and overly sluggish credit growth, First Capital Research expects a continuation of the rates while permitting the effect of the recent rate hike to materialize. However, probability of a rate cut exists beyond 1Q 2019 to boost the revival of economic activities. First Capital Research expects the CBSL to keep Statutory Reserve Ratio (SRR) unchanged at 6.00 percent.