Persistent virus restrictions could delay rise in interest rates as economy will require more support

The interest rate could stay lower for longer than expected, as the economy battered by the virus-related restrictions will require increasingly more fiscal and monetary support at a time when the government’s revenue has come significantly under pressure, due to dampened business and consumer activity caused by the stubborn stay-at-home orders. 

In the lead up to the fresh restrictions, market participants expected the interest rates to start rising from the 2H of 2021, as the excessively dovish monetary policy maintained for over two years would lead to higher consumer prices and weaker currency, the two phenomena in fact at play at present.  Their views gained more ground from around February, as the yields of the government securities started edging up, signalling in what could potentially be the end of the current monetary easing cycle. 

However, the fresh round of restrictions starting from the third week of April, due to the virus resurgence, changed all that and the market participants now get ready for a longer stretch of low interest rates than they earlier anticipated would last. 

“The government’s revenue shortfall and slower economic growth is resulting in further quantitative easing leading to higher Central Bank holdings and further improvement in liquidity levels in the money market,” First Capital Research said making a case for why the domestic interest rates could stay lower for longer. 

As the economy is strangled by the virus-containing restrictions, the government loses an enormous amount of tax revenue, as large swaths of businesses remain closed while consumer activity is at semi-dormant level, confined only to essential stuff. 

The decisions by the private sector commercial banks to close their operations for the week through June 13, which was later reversed, was an indication that the economic activities have plunged to a dismal level, where it no longer makes any commercial sense for them to remain open for business.  

Meanwhile, the government’s expenses skyrocket, due to the unexpected spending for virus-containing activities, mass testing, mass vaccinations and welfare transfers to millions who lost their livelihoods, on top of sustaining stay-at-home public servants, who deliver no meaningful work at all.

The government estimated a single round of welfare transfers, which trigger due to lockdowns, cost them up to a mammoth Rs.30 billion.  

And to fund this expanding gap in the budget, the cash-strapped government will have to rely on the domestic means and therefore will have to keep the interest rates from rising to keep their borrowing cost at a minimum.    
“The third wave of COVID-19 is further supporting the situation with an aggressive lockdown, slowing down the economy yet again. We believe the current pandemic situation may further slowdown the rise in interest rates ensuring the continuity of the low interest rate environment,” the research firm added. 

Sri Lanka is on a path to economic disaster, as large swaths of small businesses are going out of business every day, throwing hundreds of thousands of people out of jobs, pushing many millions more into poverty, as it chose the easy path of strangling its economy, which already had very slim buffers to withstand anymore shocks, to contain a virus, which can and should be managed while maintaining a working economy.