Policy rates likely to be held steady: First Capital

• CB likely to give time for earlier policy decisions to have impact 
• Change of rates ahead of Presidential Election unlikely 
• Monetary Board could keep rates unchanged for rest of 2019 
• $ 500 m Samurai bond to top up reserves  

First Capital Research yesterday said expectations were for the Central Bank to keep its policy rates unchanged when it announces its latest Monetary Policy stance later this week as the monetary authority has already relaxed rates twice this year and is therefore more inclined to wait for the impact of the previous decisions to materialise. 

First Capital Research acknowledged that contrary to its expectations, the Central Bank decided to reduce SDFR and SLFR by 50bps each to 7% and 8% respectively, with the aim of boosting credit flows to productive sectors and in turn to assist the revival of the economy. With the Presidential Election scheduled for next month it is unlikely the Central Bank will change its policy rates at this point, the report observed.  

“The Central Bank is extremely unlikely to change its key monetary policy rates amidst the uncertainty of the Presidential Election around the corner. The reduction of policy rates in August which was way in advance also supported this view,” it said. 

Since the previous rate cut on 23 August, the rupee depreciated by 1% amidst foreign outflows amounting to Rs. 13.8 billion, which resulted in foreign holdings in Government securities declining below 2%, the lowest in recent times. 

“Considering the previous 50bps rate cuts each in May and August and imposition of lending caps, First Capital Research believes that policy change is not required for the year 2019 while allowing the impact of previous policy decisions to materialise. Accordingly, we expect Monetary Board to hold rates for the rest of the year 2019.”

GDP growth for the 2Q2019 recorded at 1.6% significantly lower compared to 3.9% recorded in 2Q2018. In order to address the overly sluggish credit growth, over the past 11 months, the Central Bank undertook a number of monetary policy and regulatory measures to induce a reduction in market lending rates and thereby boost the GDP growth of the country.

Accordingly, the Central Bank reduced its policy rates by 50bps each in May and August and also reduced the SRR applicable on rupee deposit liabilities of Licensed Commercial Banks by 2.50% in order to improve the liquidity in the financial market. These measures were expected to stimulate the demand for credit while improving GDP growth of the country.

The growth of credit extended to the private sector has increased marginally by 1.16% since the beginning of this year, remaining far below the levels observed in the corresponding period of 2018, while NPLs have grown due to various factors. The Central Bank is of the view that excessively high nominal and real lending rates are a key reason for slowing credit expansion and rising NPAs. Moreover, SL’s real lending rates are found to be unacceptably high compared to its peer economies. 

Accordingly, the Monetary Board decided to order the Licensed Banks to reduce interest rates applicable on all rupee denominated loans and advances by at least 200bps by 15 October, in comparison to the interest rates applicable as at 30 April. 

Moreover, in the case of credit card advances, the maximum interest rate applicable has been reduced to 28% per annum. These measure are expected to lower market lending rates by banks, thereby boosting credit flows to productive sectors. This, along with improved repayment capacity of borrowers at lower interest rates, was expected to strengthen licensed banks, by addressing the challenge of rising NPLs.

The Government appointed a bid manager to raise $ 500 million via Samurai bonds while the issuance will take place in October or November ahead of the Presidential Election. 

“We believe existing foreign reserves ($8.5 billion as at 30 August) are at a comfortable stage with sufficient foreign repayment cover suggesting the lower foreign currency requirement.  The new Samurai bond issue is expected to add a further cushion to foreign reserves.”