First Capital says 80% probability for policy rates to stand pat on Thursday

First Capital Research (FCR) expects the Monetary Board of the Central Bank to maintain the policy rates at the upcoming monetary policy review—the first one for 2020—on Thursday, as there is ample space for the market lending rates to come down without further adjustment to policy rates.

However, the research house has assigned a lower probability of 20 percent for a rate cut with the urgency shown by the authorities to boost the revival of economic activities.
FCR has also assigned 100 percent probability for policy rates to be kept unchanged in the first quarter of 2020. 

“We continue to maintain that SRR is likely to be remained at the current level.” At the last monetary policy review in December, the Central Bank kept the policy rates unchanged, saying that the stimulus provided by the government was adequate to boost the economic activities to satisfactory levels.

Accordingly, the Standing Deposit Facility Rate (SDFR) and Standing Lending Facility Rate (SLFR) of the Central Bank were kept at 7.00 percent and 8.00 percent, respectively.

The newly-elected government of President Gotabaya Rajapaksa has introduced sweeping tax cuts and abolished certain taxes, such as the Nation Building Tax and Debt Repayment Levy, to stimulate the economic activities.

The government also slashed corporate taxes, including a significant reduction in the tax rates applicable on sin industries and introduced a one-year debt moratorium for the struggling small and medium-sized enterprises.

“The stimulus package may potentially lead to fiscal slippage, reducing the possibility of further monetary easing in the near term,” FCR cautioned.

Sri Lanka’s economy grew by 2.7 percent in the second quarter of 2019, higher than the 1.6 percent in the second quarter.

Private credit has also slowly picked up with an increase of Rs.47.1 billion in November 2019, recording a positive credit growth for the fourth consecutive month with January-November 2019 growth at 3.5 percent.

FCR expects 5 percent credit growth for 2019. Also, Sri Lanka’s government securities market witnessed a net inflow since the beginning of this year despite the outlook downgrades by Fitch Ratings and S&P due to the sweeping tax cuts announced by the government.

The inflows amounted to nearly Rs.5.5 billion and are expected to gradually improve during the first quarter with the settling of political uncertainty.

Meanwhile, FCR expects inflation to remain at low-single-digit levels and stabilise within 4-6 percent range while the market lending rates are expected to reduce further.

“…we expect a gradual acceleration in inflation to continue in the first half, primarily driven by the supply-side shortage relating to food, due to the floods in November. However, the inflation is only likely to rise to around the 6 percent mark as tax cuts are expected to partially offset the food inflation,” FCR said.