ECONOMYNEXT – Sri Lanka rupee ends stronger at 185.10/30 to the US dollar in the spot market on Monday while gilt yields slightly up in active market trade, dealers said.
The rupee closed at 185.50/80 to the US dollar on Friday.
In the upcoming policy review on November 26, FirstCapital Market Research notes in its pre-policy analysis that the central bank could either cut the policy rate or keep it at the previous levels with the chances for both standing at 50/50. While it vouches for a rate cut.
Its arguments for a policy rate cut are:
A thrust for Development: the need of the current government
First Capital Research estimates that Sri Lanka’s GDP would see its steepest contraction in the history of -5.8% in 2020 following the unexpected contraction in 1Q GDP growth of -1.6% while 2Q GDP figures are yet to be seen. However, the current Govt.’s key drive is the development-oriented economic growth which was spelt out through the Budget 2021 as well. Accordingly, Govt. plans to reach 6% and above GDP growth during the next 5 years commencing from 2021. As we believe a development-oriented budget coupled with further low-interest-rate environment can support the Govt.’s medium-term goals. Therefore, the need to accelerate the GDP growth can be considered as a major factor favouring, further policy easing at the upcoming review.
Access to less expensive domestic funding
It is reasonable to assume that Govt. is more focused on domestic funding to finance the budget deficit. This is reflected by the improved domestic to foreign debt ratio to 54:46 by end Jul 2020 from the previous 51:49 as at end of 2019. In the midst of limited access to the international financial markets, Govt. opt to rely more on domestic borrowings to finance the budget deficit and hence easing rates at the upcoming policy meeting results in reduced funding cost favouring the Govt.
Yields heading north with auctions being undersubscribed
Despite the improved liquidity position, yields in the secondary market witnessed a slight increase with low activities as market participants followed a wait and see approach amidst the looming uncertainty. T-Bond auction on 12th Nov and T-Bill auction on 18th Nov were both undersubscribed by a considerable amount reflecting the lack of clarity of market participants with the given economic condition and COVID 19 impacts.
“We believe a rate cut would be a sweetener to sustain the yields at current low levels and to enhance the activities of the secondary bond market.”
While the argument against a policy change ar:
Improvement in high-frequency indicators with surplus liquidity in the system
As a response to the measures taken by the Govt, private sector credit has improved to LKR 87.4Bn in Sep while the market liquidity has reached LKR 140.0Bn by 13th Nov indicating that there is surplus liquidity in the system. Moreover, the unemployment rate, which was at 5.7% in the 1Q2020 has declined to 5.4% in the second quarter. These indicators suggest that economic activity has remained steady without much deterioration in the 2Q. Except for the GDP growth numbers, where the 2Q2020 figures are yet to be seen, other indicators are signifying a recovery, inquiring the need of further policy easing at the upcoming review.
Extended Moratorium: A solution for grievances
Considering the encounters faced by the businesses and individuals due to the second wave of COVID-19, CBSL has extended the debt moratorium for another period of six months commencing from 01 Oct. 2020. We believe that the extension of moratorium is one of the relief packages offered by the CBSL for individual/businesses to revive their business activities.
Rock bottom Market Rates!!!
In response to previous monetary easing measures implemented by CBSL, to bring down costs of borrowing of businesses and households, both market deposit and lending rates adjusted notably so far during the year. AWPR declined to historic lows in recent weeks, while banks’ lending rates also witnessed a downward adjustment in line with CBSL’s expectations. We believe that considering the recovery in the private credit and historic low levels in AWPR, there is no vital requirement for CBSL to provide a rate cut and to further bring down the market lending rates drastically.
In the secondary securities market, bond yields picked up in active market trade on selling pressure, dealers said.
A 2-year bond maturing on 15.12.2022 closed at 5.85/90 per cent on Monday, up from 5.78/85 per cent at Friday’s closing.
A bond maturing on 15.01.2023 closed at 5.88/98 per cent, up from 5.85/95 per cent from the previous day’s end.
A bond maturing on 15.09.2024 closed at 6.45/50 per cent on Monday, up from 6.40/43 per cent on Friday’s end.
A bond maturing on 01.05.2025 closed at 6.50/60 per cent, up from 6.45/55 per cent.
A bond maturing on 01.02.2026 closed at 6.80/90 per cent, gaining from 6.70/80 per cent at the last closing.
A bond maturing on 15.08.2027 closed at 7.15/20 per cent, up from 7.07/15 per cent on Friday’s end.
A bond maturing on 15.07.2028 closed at 7.25/35 per cent, gaining from 7.20/30 per cent from the previous day’s end.