Sri Lanka’s economy contracted by 1.6% in the 1Q2020, as against a 3.7% growth in 1Q2019, prompting flag off concern, as the negative growth was ahead of the COVID-19 impact.
“We expect that the impact of COVID-19 disruptions will be felt much more in the 2Q 2020, as it continued to spread throughout the country since mid March 2020,” First Capital Research in its ‘Pre-Policy Analysis’ for August 2020 said.Moreover, decline in global demand for the country’s exports and delays in raw material procurement, and no tourist arrivals due to travel restrictions further heightens the risk of lackluster GDP growth concerns for 2020E.
Despite continuous reduction in market interest rates (by 198bps from 9.38% on March 6 to 7.40% in August 7) credit extended to the private sector contracted significantly in May 2020 (Rs 70 bn) and Jun 2020 (Rs 54 bn) due to the impact of COVID-19 while YTD credit growth remains muted at 0.62%.
“However, we expect private credit to gradually pick up only towards 4Q2020 amidst the reluctance to lend due to sluggish economic conditions. Nevertheless, a further rate cut is likely to induce a support for a quick recovery by accelerating credit which is believed to be the govt’s current need of the hour.
SL’s exchange rate and foreign reserves remained at a much more comfortable position by July 2020 in the midst of USD 400 mn currency swap and with the exchange controls including import restrictions. We believe a comfortable external front reduces the detriment in providing further easing in policy rates.
Despite the improved liquidity position, yields in the secondary market witnessed a slight increase with moderated activities as market participants followed a wait and see approach amidst the upcoming policy review. “We believe a further policy cut would be required to sustain the yields at current levels in line with the low interest rate environment.”
With the reduction of SRR by 300bps and further money printing by CBSL, liquidity position reached Rs 182 billion nearly one and half months high. However, despite the significant SRR cuts since the onset of COVID-19, credit growth has been deteriorating thus inquiring the ability of further easing policy rates to stimulate the demand.
With the expected recovery in economic activities we believe that monetary policy easing can manifest in demand pull inflation.
“However, if private credit picks up at an accelerated level and if import restrictions are relaxed towards the later part of the year, that can create a situation of an overheated economy thus creating inflationary pressures.”
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