First Capital sees strong bias for rate cut

As Easter Sunday attacks further dampens Sri Lanka’s growth prospects, the Monetary Board of the Central Bank faces an inevitable situation to support the economy through a policy rate cut in the third monetary policy review meeting this week, the Colombo-based First Capital Research said.

 “First Capital Research allocates a 95 percent probability for a policy rate cut in May 2019 as we are of the view that policy intervention is inevitable to revive the overly sluggish economy and credit growth,” First Capital stated in its pre-policy analysis report.

Given the country’s overly sluggish GDP growth and below par credit growth, First Capital predicted that there is a 60 percent probability for the Monetary Board to cut policy rates by 50 bps while a lower 20 percent probability for a 75bps cut.

“Despite the Road Map towards a single policy rate, we believe a rate cut in both Standing Lending Facility Rate (SLFR) and Standing Deposit Facility Rate (SDFR) is more appropriate considering the severity of the situation. 

“However, in the case of a 75bps or a 100bps rate cut consideration, though remote, CBSL may consider a lower cut for SDFR.”  Prior to Easter Sunday attacks, First Capital predicted that the Central Bank would likely to cut policy rates by 25bps in second and fourth quarters of the year due to below par GDP growth and contraction of private credit early this year. However, the Easter Sunday attacks brought detrimental impact on key sectors of the economy such as tourism and retail, possibly further slowing down the sluggish economy. Revising earlier GDP growth projection from 4.3 percent to below 3 percent for the year, First Capital stated that it would require a minimum of one year for Sri Lanka to recover from impacts of Easter Sunday attacks. 

Despite the weakened economic outlook, Sri Lanka’s macroeconomic fundamentals have improved steadily allowing for a potential policy rate cut supporting the revival of the sluggish economy.  

“Sri Lanka’s strengthened macroeconomic fundamentals led the yield of 5-year bond to decline paving way for a possible policy rate cut,” First Capital noted. 

In addition, the Central Bank has maintained the foreign reserve position above US $ 7 billion with no sovereign bonds maturities during the second half of the year. 

First Capital stated that the government and the Central Bank have created a sustained positive liquidity position after lapse of six months resulting from multiple SRR cuts and the government fulfilling its commitments on overdue payments to contractors. Hence, the report noted that the Central Bank could now discontinue daily reverse repo auctions and term reverse repo auctions. 

Further, First Capital believes that the Central Bank is likely to maintain Statutory Reserve Ratio (SRR)‎ unchanged at current levels while noting there is a  relative small probability of raising SRR amid healthy liquidity levels.