Interest rates’ downside run could end by first half, says First Capital

First Capital Research (FCR) believes the little under two-year long downside run of interest rates could come to an end by end of the first half of this year, but the clues coming from the Central Bank and elsewhere suggest that it has more life to run its course. 

FCR is of the view that there is a possibility for the rupee to shed some value from around the second quarter of this year, which in turn would add some upward pressure on the rates. 
“….a possible steep depreciation in the currency may dampen sentiment from 2Q2021 onwards. It is likely to have an adverse impact on banking rates towards 2H2021 with potential increase in banking rates by about 200bps during 2H2021,” FCR said in its latest research note. 

However, the Monetary Board and Central Bank suggest otherwise as they expect to maintain a dovish monetary policy stance through 2021 as inflationary pressures are well anchored and the lid on non-essential imports in place. 

Meanwhile, certain other economic analysts, who also expressed views on the possibility of Sri Lanka maintaining lower interest rates for longer, said that central banks around the world, including that of Sri Lanka’s, will be very cautious in lifting their feet from the gas peddle of monetary stimulus unleashed at unprecedented levels in 2020. 

If the Central Bank could stay lower for longer, that could provide the much needed certainty to businesses on their borrowing costs and provide the impetus to the country’s equities market.
Sri Lanka typically has short-interest rate cycles, where lower interest rates often lead to spike in credit, which then fuels influx of imports and inflation forcing the Central Bank to reverse course by way of raising interest rates. 

However, the current restrictions imposed on non-essential imports and the lower aggregate demand in the economy due to COVID-19, are expected to be the difference this time.
A development that could add some pressure on the currency and thereby the rates could be the gradual rise in crude oil prices as Saudi Arabia unilaterally decided to cut supplies to maintain prices. 

Global demand for crude oil depends on the pace of the global economic rebound from the pandemic in 2021.