First Capital Research in their Pre-Policy Analysis says that reducing policy rates is one of the main tools that Central Bank of Sri Lanka (CBSL) can utilise to increase economic activity and revive the economy.
“Post pandemic, Sri Lanka’s stressed economic conditions remains a key weakness and reviving the economy is a one of the objective of the Govt. and CBSL.”
In line with our expectations (as mentioned in the pre policy report dated 28th Feb) CBSL held its policy rates steady at the meeting held on March 5, 2020 while allowing the impact of previous policy actions to materilise. “However, as a COVID-19 relief measure CBSL reduced policy rates by 100bps in 3 emergency instances reducing the SDFR and SLFR rate to 5.50% and 6.50%.” With the recent reduction of SRR by 2%, liquidity position surged over LKR 200Bn and bulk of the excess liquidity of banks is likely to be parked in SDFR facility provided by CBSL at 5.50% rather than allocating for lending.
“In order to discourage banks using the SDFR facility we consider the possibility of a major rate cut resulting SDFR a less attractive option for LCBs.”
“With the recent reduction of SRR additional LKR 115Bn of liquidity was injected into the banking system, allowing banks to accelerate credit flows into the economy, while reducing cost of funds.” “We expect LKR 100 billion top-up, in the existing refinance scheme which may enhance additional liquidity to the domestic money market above LKR 250 billion. At the current level excess liquidity is already at a 16-year high. Further top -up in existing refinance scheme may push CBSL Holding (printed money) closer to LKR 500 billion from current LKR 311billion.
“To dissuade banks from keeping excess money with the CBSL without lending, we believe that the CBSL has to reduce its policy rates substantially both ; SDFR, the rate at which commercial banks can keep overnight liquidity with the CBSL, and the SLFR, as a stimulus to boost the credit growth”
“As a result of injection of liquidity to the system CBSL holdings recorded a significant increase of more than LKR 200 billion since March 13, 2020.”
“Considering the recent reduction of SRR by 300bps to 2% we believe that further SRR cut is not required as O/N liquidity has reached all time high levels at the moment.”
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