First Capital Research estimates that Sri Lanka’s GDP would see its steepest contraction in history of -5.8% in 2020 and to see a gradual recovery of 2.8% in 2021.
“The current Government’s key drive is the development oriented economic growth which was spelled out through the Budget 2021 and is in the process of changing gears of the economy from a “recovery phase to an expansion phase,” according to First Capital –Pre Policy analysis January 2021.
Accordingly, the Government plans to reach 6% and above GDP growth during the next 5 years commencing from2021. First Capital believes a development-oriented budget coupled with a 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 is reasonable to assume that the 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 endof 2019. In the midst of limited access to the international financial markets,the Government opted 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 favouring the Government.
“In-line with our expectations, at the previous policy meeting held in November 2020, CBSL maintained its monetary policy stance, emphasizing the fact that overall market lending rates have witnessed a reduction during 2020 and there is a need for a continued downward adjustment in lending rates to boost economic growth.
“Moreover, introduction of maximum interest rates on mortgage- backed housing loans is expected to provide additional stimulus to the economy.”
First capital further said that as a response to the measures taken by the Government, market liquidity increased to an elevated level while recording a three year high January 2021 amounting to Rs 266.50 billion. Accordingly, this excess liquidity in the system is expected to retain market interest rates at single digit levels while inducing further credit expansion. This inquires the need for further policy easing at the upcoming review.
“Private sector credit increased by Rs 41 billion in November 2020 recording a growth for the fourth consecutive month indicating a revival in gross loan disbursements up to pre-pandemic levels in December 2019.
The continuous uptrend in private sector credit till November 2020 reflects that both businesses and individuals are accelerating their economic activities to make up for the lost opportunities during lockdowns in the first wave of COVID, which could power decent growth in 4Q 2020 and onwards.
“In response to previous monetary easing measures implemented by CBSL, (including the lending caps) to bring down costs of borrowing of businesses and households,both market deposit and lending rates adjusted notably so far during 2020. We believe these measures will enable it to maintain market interest rates at stable levels in 2021 while playing its aiding role amidst the pandemic driven economic contraction.”
First Capital Research added that amid the world on a money printing spree, Sri Lanka’s CBSL holdings also recorded an all-time high amount of Rs. 885 billion in December 2020 as a result of printed money by the Government in order to finance the fiscal deficit.
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