First Capital says policy rates to hold steady amidst sweeping measures to insulate economy

• CBSL holdings also recorded an all-time high amount of Rs. 885 billion on 30 December 2020

Ahead of the January monetary policy review by the Central Bank, First Capital yesterday predicted policy rates to hold steady amidst sweeping measures to insulate the economy. 

“In-line with our expectations, at the previous policy meeting held on November 2020, CBSL maintained its monetary policy stance, emphasising the fact that overall market lending rates have witnessed a reduction during 2020 and there is a need for a continued downward adjustment in lending rates to boost economic growth. Moreover, introduction of maximum interest rates on mortgage-backed housing loans is expected to provide additional stimulus to the economy,” First Capital said.

Listing arguments against further relaxation in monetary policy, First Capital said excess liquidity prevailing in the domestic market requires no change in current policy stance.

“As a response to the measures taken by the Government, market liquidity increased to an elevated level while recording a three-year high on 1 January 2021 amounting to Rs. 266.5 billion. Accordingly, this excess liquidity in the system is expected to retain market interest rates at single digit levels while inducing further credit expansion. This inquires the need of further policy easing at the upcoming review,” it said. 

Another argument is that the gradual rebound in private credit to power economic growth.

“Private sector credit increased by Rs. 41 billion  in November 2020 recording a growth for the fourth consecutive month indicating a revival in gross loan disbursements up to pre-pandemic levels in December 2019. The continuous uptrend in private sector credit till November 2020 reflects that both businesses and individuals are accelerating their economic activities to make up for the lost opportunities during lockdowns in the first wave of COVID, which could power decent growth in 4Q2020 and onwards,” First Capital explained. 

Rock bottom interest rates will gear up the economy as well, it said. 

“In response to previous monetary easing measures implemented by CBSL, (including the lending caps) to bring down costs of borrowing of businesses and households, both market deposit and lending rates adjusted notably so far during 2020. We believe these measures will enable to maintain market interest rates at stable levels in 2021 while playing its aiding role amidst the pandemic driven economic contraction,” it said. 

First Capital said amidst the world on a money printing spree, CBSL holdings also recorded an all-time high amount of Rs. 885 billion on 30 December 2020 as a result of printed money by the Government, in order to finance the fiscal deficit. “We expect the injected cash via money printing may result in increased money supply and create demand driven inflationary pressures with the recovery of economic activities. Therefore, further policy easing at the upcoming policy review is unlikely as further easing of monetary measures could result in an overheated economy,” First Capital said. 

It also listed arguments for further relaxation in monetary policy. 

One was growth-oriented endeavours. “We estimate that GDP would see its steepest contraction in history of -5.8% in 2020 and to see a gradual recovery of 2.8% in 2021. The current Government’s key drive is the development oriented economic growth which was spelled out through the Budget 2021 and is in the process of changing gears of the economy from a recovery phase to an expansion phase. Accordingly, Government plans to reach 6% and above GDP growth during the next five years commencing from 2021. As we believe a development-oriented budget coupled with low interest rate environment can support the Government’s medium-term goals. Therefore, the need to accelerate the GDP growth can be considered as a major factor favouring further policy easing at the upcoming review.

Access to less expensive domestic funding is another argument, First Capital said. 

“It is reasonable to assume that Government is more focused on domestic funding to finance the budget deficit. This is reflected by the improved domestic to foreign debt ratio to 54:46 by end July 2020 from the previous 51:49 as at end of 2019. In the midst of limited access to the international financial markets, Government opt to rely more on domestic borrowings to finance the budget deficit and hence easing rates at the upcoming policy meeting results in reduced funding cost favouring the Government,” it added.