HSBC forecasts Central Bank to slash key rates by 500bps over next 12 months

• Asia focused British lender says recovery in SL goes ahead with reforms and inflation cools 
• 300bps cut in rates expected in second half of 2023 and further 200bps in first half of 2024
• Lankan economy contracted by a sharp 11.5% in 2023 first quarter

HSBC Global Research has forecast further 500 basis points rate cut in Sri Lanka over the next four quarters after the country’s Central Bank signaled further easing in its ultra-tight monetary policy when it delivered a surprise 250 basis point policy rate cut earlier this month. 

While a turn in the monetary policy was expected at any time this year due to persistent contraction in the economy, the June cut in rates was made possible by the larger than expected ease in the inflation in both April and May. 

The inflation measured by the mostly-watched Colombo Consumer Price Index fell to a somewhat conciliatory level of 25.2 percent in May from a year ago, easing further from 35.3 percent through April, although much of the deceleration occurred due to higher base effects last year. 

Analysts at HSBC remain confident that Sri Lanka’s inflation would return to single digit levels by the end of the year, that too is based on higher base effects and thus providing room for the members of the rate setting committee to cut rates at least by another 300 basis points this year, equally split between the third and the fourth quarters before continuing with the easing path through next year.

“The Central Bank recently cut policy rates by 2.5 pct in a bid to bring down domestic interest rates. As the structural reforms gain traction and the ongoing recovery gains momentum, we think the CBSL is likely to ease monetary policy further,” said Aayushi Chaudhary, an Economist at HSBC Securities and Capital Market (India) Private Limited in a note following the release of Sri Lanka’s first quarter GDP data last week. 

Chaudhary anticipates a further cumulative 200 basis points cut in the first half of next year—100 basis points cut in rates each in the first and the second quarter—bringing the policy rates to a range of 9-8 percent.
If the Central Bank was to implement the forecast path by HSBC, it would reduce policy rates by 750 basis points out of the total 900 basis points delivered from April last year to March this year.

Currently, the SLFR and the SDFR stand at 14.0 and 13.0 percent, respectively. 
Current market lending rates which are still above 20 percent in many cases hinder credit flows to businesses, which could resuscitate production and restore supplies.
Chaudhary in her note said while the recovery in the economy is underway and the back half of 2023 would most likely report a growth in annual terms, the full year growth would still remain negative due to the deep contraction in the first half.

Sri Lankan economy contracted by a sharp 11.5 percent in the first quarter of 2023 from the same quarter last year due to base effects but the pace of contraction had slowed further on an adjusted sequential basis, she added.