Further easing of interest rates likely: ICRA Lanka

Expectations run high on further easing of interest rates in December and in the months that follow, as the lending rate caps take effect and the recent sweeping tax cuts factor into the real economy. 

According to a regular monthly economic update by ICRA Lanka, part of Moody’s Investors Service, the post-election euphoria and the subsequent tax cuts gave a tailwind for the rates to ease faster while the September-end lending rate caps were slowly taking effect.

“With the recent reduction in taxes, the lending rate may further subdue in December. 

Long-term interest rates are likely to experience further decline,” ICRA Lanka’s November Economic Update said.

The yield curve, which acts as a barometer for the broader market rates, experienced a sharp downward shift across the board, following the presidential election on November 16, with heightened activity levels in the bond market.

However, the yields went through a minor upward correction as the foreigners, who bought rupee bonds leading up to the election, started exiting by exploiting on the improved local investor sentiment. 

“Fall of shorter tenor bond yields have steepened the yield curve indicating investors’ expectation about economic recovery in the medium to long run,” ICRA 
Lanka said. 

During the week ended December 11, foreigners sold net Rs.8.18 billion worth of rupee bonds, the highest weekly foreign outflow in nearly four months. The stock market also saw a net outflow of Rs.451 million during the week ending December 12. 

According to the analysts who track the movement in foreign holdings on a regular basis said foreigners have been exiting for several months due to the increased local interest. 

They said despite the outflow, which mainly came from foreign institutions, foreign individuals are still collecting local stocks.

Sri Lanka’s interest rates spiked since 2016 after two years of low rates, creating instability in the economy. Businesses scaled down their operations amid sluggish consumption and banks ran into trouble from increased non-performing loans.

The new administration, which pledged to unshackle the economy from the grips, introduced a slew of tax cuts to provide space for the economic actors to unleash 
their potential.

But some have cautioned that the stimulus package could backfire as the country has repeatedly seen fiscal instability spilling over into other sectors of the economy forcing such stimulus to be replaced with even tighter policies. 

Soon after the tax cuts were announced, Moody’s estimated the impact of the tax cuts on government revenue to be between 1 to 1.5 percent of GDP. The Finance Ministry said the fiscal deficit is likely to hit 7 percent, significantly overshooting the previous estimates.

However, the government expects the tax cuts to provide the much-needed fillip to the businesses and the heightened economic activities backed by the increased consumer spending will generate more revenues to the state.

The present Central Bank Governor Dr. Indrajit Coomaraswamy is set to step down on December 20 and it is unlikely the new governor yet to be announced would resort to some drastic policy decisions in his/her first monetary policy meeting, likely in January 2020.  

The new administration does not appear to be inclined to continue with the lending rate caps, which were brought in end-September to rein in the higher lending rates and spur private sector lending.