Citibank doesn’t rule out further rate hikes by CB

• Says another rate hike likely by year end and further hikes during 2022 
• Forecasts inflation to breach CB’s upper bound of 6% by year end 
• Says lack of fiscal space and prospects for higher interest rates could make tax hikes likely 
• Predicts debt mgt. challenges to nudge country closer to an IMF programme 

Citibank in a note issued soon after last week’s monetary policy action said although the Central Bank would pause for sometime given the temporary respite they may get from the envisaged foreign inflows via swaps and others, it did not rule out further hikes in policy rates towards the end of the year and next year to keep external challenges in check. 

The Central Bank on Thursday raised its key policy rates by 50 basis points and the banks’ statutory reserves ratio by 200 basis points to address the external sector imbalances among others. Although the timing of the move came as a, “surprise”, to Citibank, they said the, “tightening of monetary policy to address external imbalances is not”.

“ We expect the CBSL to pause for now given the recent CDB loan, pending SDR allocation, US$ 50 million from Bangladesh swap and possible RBI swap, but more rate hikes may prove hard to avoid as we see a 50 bps raise as unlikely to be enough to boost confidence in holding rupees,” the US-headquartered multinational lender said.
There was a widening disparity building up between the dollar assets and the rupee assets, and last week’s monetary board’s decision was aimed at partly narrowing this gap. 

To further address the issue and thereby close any undue advantage of holding dollar assets over rupees, the Central Bank is also mulling to place a interest rate cap on dollar deposits held by exporters. 

 However Citibank analysts do not believe the 50 basis point hike in policy rates would be enough to increasing the confidence to hold rupees over US dollars of which the returns are higher. For instance they cited the Sri Lanka Development Bonds which offer a yield of 7.82 percent.  Therefore they penciled in another 25 to 50 basis points hike in policy rates by the year end and another 100 - 150 basis points hike in 2022, while allowing the foreign exchange rate to depreciate further.

Further they are also unsure if the last week’s actions would by any means allay the concerns over the future external debt repayments amid the dampened prospects of revival in the tourism trade and other broader economic activities amid the reimposed lockdowns to stem the virus spread.  Given these trying circumstances which were further exacerbated by the lack of direct investment inflows as earlier hoped for, Citibank in a recent report expressed their skepticism over the country’s ability to meet the next billion dollar sovereign bond settlement falling due in July next year. 

As a result, Citibank reiterated of the increasing likelihood of the country to eventually seek the International Monetary Fund (IMF) programme support, not long after the January 2022 sovereign bond maturity. 
An IMF programme, they said would, “help unlock official financing sources that are conditional on policy adjustments alongside debt restructuring”. 

They also forecasted the inflation to breach Central Bank’s upper bound of the desired inflation range of 6.0 percent by the year end due to exchange rate pass-through on inflation, supply side risks exacerbated by import controls and worries these controls will tighten in the future, increase risk of speculative hoarding that would amplify inflationary pressures.  Citibank also expects the possibility of tax hikes due to limited fiscal headroom from the prospects of higher interest rates amid already heavier interest burden on State revenues which accounted for 76 percent of revenues during the first four months. 

“With the interest burden rising, flexibility to reduce borrowing requirements through expenditure cuts will be challenging, heightening the need to raise revenues”, they added.