By First Capital Research
Previous Pre-Policy issue; CBSL continues to support liquidity
Contrary to our expectation of unchanged policy stance, CBSL reduced the SRR by 100 bps to 5 per cent as they believed policy intervention was required to address the large and persistent liquidity deficit prevailing in the domestic money market.
Changes that took place during the period:
= Sluggish sentiment in Sri Lanka’s economy has been a major concern, with latest GDP growth for 4Q2018 recording an alarmingly low 1.8 per cent. Growth protracted in 2018 with annual GDP growth trimming to 3.2 per cent compared to 3.4 per cent in 2017.
= Supported by the SRR cut in February 2019, liquidity position saw a significant improvement. More recently, the minor level of foreign inflows and the subsequent foreign remittance conversions are having an impact on liquidity curtailing the deficit, while we expect the situation to further improve over the next few weeks.
= Political uncertainty has worn off to a certain extent with the TNA supporting the UNF Government on the passing of the Budget.
External sector strongly favouring Sri Lanka
= The Fed signaled the pausing of rate hikes in 2019, while certain analysts expect possible reversal in stance to a single rate cut in late 2019. Global fund flow, which is already shifting towards emerging markets, is likely to further strengthen and continue with the U.S. yields easing off.
= The USD:LKR continued to strengthen to close at 176.17 on 28 March 2019, supported by foreign remittance conversions and foreign inflows. We expect the REER to have reached 97-98 range with the rupee appreciation together with the strengthening of the dollar index in February and March 2019. REER for January 2019 recorded at 94.18, indicating the undervaluation of the currency.
= Resultant to the continuous foreign inflow witnessed in the secondary market since March 2019, short to belly-end of the yield curve plunged by 5-23 bps, shifting downwards, while equity market witnessed a net foreign outflow.
First Capital Research allocates a 50 per cent probability for a policy rate cut in April 2019, as we are of the view that policy intervention is appropriate to address the overly sluggish economic growth. Keeping in line with the possible introduction of a single policy rate, we believe a rate cut, if at all, will be applicable only to SLFR. However, considering the negative liquidity position, we allocate a further 50 per cent probability for no change in rates, as CBSL may consider to delay the rate cut upto the next policy meeting in May 2019.
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