First Capital Research believes that the Central Bank of Sri Lanka (CBSL) will maintain the same policy stance in this monetary policy review, but given the concerns around economic growth, the research arm stated that the CBSL is likely to retain the monetary policy stance at “accommodative”.

"As per our view, CBSL either can choose to hold policy rates steady or cut by a 25bps or 50bps while, hike is off the table due to the lackluster economic growth. We believe that there is a 50% probability to hold rates due to improvement in high frequency indicators. Moreover, there is a 25% probability for 25bps and 50 bps respectively to support economic growth," First Capital Research said in its latest report.

At the last policy meeting held on October 2020, CBSL maintained its monetary policy stance, particularly as market lending rates are yet to reflect the full pass-through of policy easing measures implemented thus far.

The next CBSL’s monetary policy review is scheduled to be announced on 26th November 2020 at 07.30 am.

Key Arguments by CBSL for maintaining its policy stance on 22nd October 2020 as follows;

• Global monetary policy stance remained to be accommodative with the resurgence of COVID-19 pandemic across the many countries in the globe.
• Despite the surge in COVID-19 cases during recent times and negative impact to the economy during near term, high frequency data suggests that Sri Lanka is on a path towards economic revival.
• In response to previous measures, market interest rates have reduced and has declined to historic lows.
• Inflation to remain within the desired level of 4%-6%.
• Credit to the private sector picked up in Sep as well and is expected to gradually recover in the period ahead.

Meanwhile, First Capital Research estimates that Sri Lanka’s GDP would see its steepest contraction in history of -5.8% in 2020 following the unexpected contraction in 1Q GDP growth of -1.6% while 2Q GDP figures are yet to be seen.

"However, the current Government’s key drive is the development oriented economic growth which was spelled out through the Budget 2021 as well. Accordingly, Government’s plans to reach 6% and above GDP growth during the next 5 years commencing from 2021," it said.

The research arm further stated that it believes, a development-oriented budget coupled with further 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.

It further stated that as a response to the measures taken by the Government private sector credit has improved to Rs.87.4Bn in September while the market liquidity has reached Rs.140.0Bn by 13th November indicating that there is surplus liquidity in the system.

Moreover, the unemployment rate, which was at 5.7% in the 1Q2020 has declined to 5.4% in the second quarter. These indicators suggest that economic activity has remained steady without much deterioration in the 2Q. Except the GDP growth numbers, where the 2Q2020 figures are yet to be seen, other indicators are signifying a recovery, inquiring the need of further policy easing at the upcoming review.

Considering the encounters faced by the businesses and individuals due to the second wave of COVID-19, CBSL has extended the debt moratorium for another period of six months commencing from 01 October 2020. 

First Capital Research believes that the extension of moratorium is one of the relief packages offered by the CBSL for individual/businesses to revive their business activities.

"In response to previous monetary easing measures implemented by CBSL, to bring down costs of borrowing of businesses and households, both market deposit and lending rates adjusted notably so far during the year."

"AWPR declined to historic lows in recent weeks, while banks’ lending rates also witnessed a downward adjustment in line with CBSL’s expectations."

First Capital Research believes that considering the recovery in the private credit and historic low levels in AWPR, there is no vital requirement for CBSL to provide a rate cut and to further bring down the market lending rates drastically.

The research arm further noted that 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 favoring the Government," it added.

"Despite the improved liquidity position, yields in the secondary market witnessed a slight increase with low activities as market participants followed a wait and see approach amidst the looming uncertainty."

"T-Bond auction on 12th November and T-Bill auction on 18th November were both undersubscribed by a considerable amount reflecting the lack of clarity of market participants with the given economic condition and COVID 19 impacts."

First Capital Research believes a rate cut would be a sweetener to sustain the yields at current low levels and to enhance the activities of the secondary bond market.