Strong case for another policy rate cut: ICRA Lanka

• Says rates have bottomed and Treasury yields experiencing pressure amid liquidity shortages
• Point out that rate cut could aid deceleration seen in industry and services activities 
• Says such move could also forestall any economic burden from partial lockdown currently underway 
• Monetary Board to announce 7th monetary policy review on October 22

Contrary to the popular belief that Central Bank’s Monetary Board would stay pat at the next week’s policy meeting, ICRA Lanka observes more reasons are building up for the rate setting committee to consider a rate cut as opposed to why it should not do so. 

According to ICRA Lanka Limited—a part of Moody’s— there is pressure building up on Treasury yields to rise amid liquidity shortages, and the already bottomed money market rates might also compel the Monetary Board to provide more support to the economy, which appeared to have lost some momentum after the early gains made in the aftermath of the lockdowns. 

Industrial and services activities seemed to have flattened in August and operating with a slack as seen from the levelled demand for power—measured by electricity generation—and there could be some economic burden from the partial lockdowns currently underway, said ICRA Lanka. 

The seventh Monetary Policy review which was due on October 16 was postponed to October 22 and there was broad-based consensus that the Monetary Board would keep the rates unchanged at the current levels after 250 basis points cut in four instances so far this year to support the recovery of the economy beset by the pandemic. 
Policy rates cuts, liquidity injections, re-finance schemes and other measures taken to bring down the cost of borrowings in the economy are already making adjustments to market interest rates and thus a section of economic analysts believes that the Monetary Board would keep the rates unchanged as earlier measures have more room to run their course. The demand for credit also appears to be recovering as seen from the Rs.78 billion given to private borrowers in August on a net basis.

However, the other analysts believe that the dovish members of the Monetary Board could be extremely generous in providing further assistance to the economy in light of the already bottomed rates and the indication of slowdown in the pace of economic growth amid fresh signs of the virus resurgence. 

“Recent string of infections related to the Minuwangoda cluster and other pockets around the country have cast a long shadow over prospects of faster recovery. It also poses a bleaker outlook for industrial exports, which is the need of the hour to accumulate reserves and protect the value of the currency,” ICRA Lanka said.

The rating agency also cited the likely asymmetry in liquidity among market participants remaining high as another reason why the Central Bank should consider cutting rates. Meanwhile, money market rates, which no longer have the downward mobility as prevailing rates are virtually converged on the lower bound of the policy corridor, could 
prompt action. There was speculation in the run up to the billion dollar sovereign bond settlement on October 2 that it could create a liquidity shortage in the rupee money market, but the Central Bank purchased Rs.123.1 billion worth of Treasury bills from the government to partially support the bond repayment while it conducted open market operation auctions in a sign that it is committed to maintain a surplus in the money market. 

The overnight liquidity, which slumped to Rs.139.40 billion on October 2, soon backed up to Rs.177.04 billion in less than two weeks.  The Treasury bill auction held this week saw it receiving nearly twice the amount offered to raise Rs.40 billion. The Central Bank accepted Rs.1.6 billion in three-month bills, Rs.12.7 billion in six-month bills and Rs.25.7 billion in one-year bills.  The yields of the three and six months bills rose by two basis points and one basis points, respectively to 4.59 percent and 4.71 percent while the yield of the one-year  bills was held at 4.99 percent, unchanged from last week.