StanChart expects over 25bps rate hike this year

Standard Chartered global research team-from left: Europe Chief Economist Sarah Hewin, Chief Economist David Mann, Macro Strategist Mayank Mishra and South Asia Economist Sourav Anand

The Standard Chartered (StanChart) global research team yesterday said they are expecting an above 25 basis points (bps) hike in Sri Lankan policy interest rates this year to build a buffer for foreign exchange reserves, as the country’s external side vulnerabilities remain significantly high.
Currently, the standing deposit facility rate (SDFR) stands at 7.25 percent and the standing lending facility rate (SLFR) at 8.75 percent. The last hike of 25 basis points was in March, 2017.

“We are the only one who is expecting an above 25 basis points hike in the rates this year” Standard Chartered South Asia Economist Sourav Anand told reporters in Colombo.

He said Sri Lanka’s external vulnerabilities remain high, largely due to the sovereign bond payments that are starting from next year. As a result, he said, Sri Lanka needs to build foreign exchange reserves and maintain the interest rate differential, which it has with global markets. According to Moody’s Investors Service, Sri Lanka has as much as US $ 14 billion foreign debt service payments coming up for 2019-2022 and US $ 2.4 billion worth of foreign debt is to be settled this year. 

The International Monetary Fund (IMF) also in the latter part of last year told the Central Bank to be prepared to tighten monetary policy if inflation and credit growth continue to remain high.

According to Standard Chartered, inflation is likely to be in the range of 5-6 percent this year, which is in the comfort range for the Central Bank while private sector credit growth is likely to be around 13-15 percent, slightly above the Central Bank’s comfort range but still deemed manageable.

Meanwhile, Anand noted that the monetary tightening by the major central banks will also push Sri Lanka to hike its policy rates going forward.

The US Federal Reserve is expected to hike rates as early as this March, gradually tapering its stimulus programme marking an end to the monetary experiment it started to recover from the global financial crisis which happened 10 years ago.

The March rate increase is expected to be followed by at least two rate hikes during this year.
The European Central Bank (ECB) and Bank of Japan (BoJ) are also expected to taper their quantitative easing programmes, which were initiated more recently.

“…so with Fed normalization, the potential for rate hike is actually building up and ECB is looking to hike rates by early 2019; there is that probability that Sri Lanka needs to increase the rates in the second half if not in the first half to build buffer for the FX reserves,” Anand said. 

Although Sri Lanka’s Central Bank is confident of achieving US $ 10 billion in foreign exchange reserves by the end of this year, the Standard Chartered research team forecasts Sri Lanka to end this year with US $ 9 billion in reserves. 

However, despite the lower reserve forecast, Standard Chartered expects the Sri Lankan economy to grow 5 percent this year compared to a consensus of 4.5- 4.7 percent growth expectation.

“The primary reason, which is also the biggest risk factor to our assumption, is the weather,” Anand said.

Sri Lanka’s agriculture sector is estimated to have contracted 3.5 percent last year due to adverse weather conditions. “This year if we have decent weather, the agriculture will itself lead to wing 50 basis points growth in the GDP,” Anand noted.

Sri Lankan exports are also set to benefit from the regaining of GSP Plus and the synchronized growth in European and US economies.