Monday, 24 March 2014 00:01
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By Asia Wealth Management
Monetary authorities held policy rates at current levels in spite of the growing volume of savings, low inflation and improving external position of the economy against the background of stymied growth of credit to the private sector.
However, a further cut in rates remains a possibility during the second half of the year mainly on account of two important trends currently taking root in the economy.
The first phenomenon to note would be that the sharp fall in interest rates seen in recent times has not in turn caused rates on consumer credit to drop equally, possibly due to relatively high nonperforming loans being concentrated in the consumer sphere.
Further, given that consumer loans occupy circa 40% of the total loans to private sector by commercial banks, room for monetary authorities to cut rates further increases as balance of payments position will not be adversely affected due to the lower propensity for consumer lending rates to fall compared with the average rate of lending in the economy, in the face of a rate cut.
Loans growth in to investments in fact has a lower negative impact on balance of payments as it may not cause a leakage of funds from the economy to the level of consumer sector credit growth. Hence, under this backdrop, a window of opportunity remains for policy rates to fall further possibly during the second half of the year.
On the other hand, export receipts coupled with inflow of labour remittances continue to rise notably while the expansion of the domestic market compared to rising export receipts remains moderate. This is indicated by credit growth to private sector dropping to 5.2% YoY in January 2014 while export receipts growth jumped to 23.2% YoY during the corresponding period. This particular phenomenon causes the liquidity levels in the financial systems to rise causing an expansion of bank liabilities (savings) at a faster pace than loans and advances to private sector (a segment of assets). This particular phenomenon tends to raise the demand for government bonds by the domestic banks owing to the high liquidity levels prevailing in the domestic financial system. Under this backdrop, primary market yields have continued to drop moderately coupled with that of the average lending rate in the economy.
The domestic demand for treasury securities despite foreign divestments is causing the yields to behave in this pattern. On the back of these developments we expect the domestic treasury yields and market interest rates to fall further marginally, assisting the equity trade in the Colombo Bourse.
However, on the other hand, interest rates in the long run may increase on the back of winding down of Fed’s quantitative easing program and the scheduled increase in U.S. policy rates in mid 2015.
