• Follows US rate hike and stubbornly-high private sector credit
• Says “precautionary measure” to contain inflation through credit expansion 
• Noted improvement in fiscal operations and meeting 2016 Budget deficit target 
• Expects inflation to moderate after adjustments to new taxes 
• Private sector credit decelerated to 20.9% in January from 21.9% at end 2016

Bowing to expectations, the Central Bank yesterday raised policy rates in step with the US rate hike and to buttress the economy against inflation and stubbornly-high private sector credit, following lower than expected growth numbers for 2016. 

The Central Bank, releasing its monetary policy stance, said the move was a “precautionary measure” to contain the build-up of adverse inflation expectations and the possible acceleration of demand side inflationary pressures through excessive monetary and credit expansion. 

“The Monetary Board also took into account the notable improvements in fiscal operations, which have resulted in the overall budget deficit in 2016 declining to envisaged levels. The Board was of the view that these improvements, together with the substantial upward movements already observed in market interest rates, have reduced the required adjustment in policy interest rates,” it said in the statement.  

Accordingly, the Monetary Board decided to increase the key policy interest rates of the Central Bank, namely the Standing Deposit Facility Rate (SDFR) and the Standing Lending Facility Rate (SLFR) by 25 basis points each, to 7.25% and 8.75%, respectively.

As per the provisional estimates of the Department of Census and Statistics (DCS), the Sri Lankan economy grew by 4.4% in real terms during 2016 compared to the growth of 4.8% in 2015. Within this annual growth, Industry-related activities grew notably by 6.7% driven by construction related activities, while Services-related activities grew by 4.2% mainly with the expansion of financial services, insurance and telecommunications. 

However, Agriculture-related activities contracted by 4.2% in 2016, impacted by supply side disruptions on account of floods in the second quarter and drought conditions during the final quarter of 2016. 

In spite of challenging external factors such as adverse weather conditions and global developments, an acceleration of growth was observed towards end 2016 with the last quarter of 2016 recording a growth of 5.3%, partly supported by the base effect.

In the meantime, headline inflation, as measured by the year-on-year change in the Colombo Consumers’ Price Index (CCPI, 2013=100), accelerated to 6.8% in February 2017 from 5.5% in January 2017. A similar trend was observed in the National Consumer Price Index (NCPI, 2013=100) based headline inflation, which rose to 8.2% (year-on-year) in February 2017 from 6.5% in January 2017. Year-on-year core inflation based on both CCPI and NCPI also remained high at 7.1%in February 2017. 

“The recent acceleration in inflation is largely due to the impact of prevailing drought conditions and adjustments to the tax structure, and it is projected that inflation would revert to the desired mid-single-digit levels in the period ahead and stabilise thereafter, unless disrupted by adverse inflation expectations,” the statement added.  

The earlier tightening of monetary policy and monetary conditions by the Central Bank and the resultant increase in market interest rates are likely to have impacted the growth of credit to the private sector by commercial banks to some extent. Accordingly, the year-on-year growth of private sector credit decelerated further to 20.9% in January 2017 from 21.9% at end 2016. 

Meanwhile, credit to the public sector increased noticeably, causing year-on-year broad money (M2b) growth to remain high at 17.7% in January 2017, although this was a deceleration compared to 18.4% in December 2016. Nevertheless, the deceleration in monetary and credit aggregates has been slower than expected.

On the external front, the deficit in the trade account of the balance of payments (BOP) was recorded at $9.1 billion in 2016 compared to $8.4 billion in 2015, with expenditure on imports increasing by 2.5% and earnings from exports contracting by 2.2% during the year. Provisional data for January 2017 also indicated a widening of the trade deficit. Earnings from tourism and workers’ remittances continued to cushion the adverse impact of the trade deficit on the BOP. 

In the meantime, outflows of foreign investments from the Government securities market observed in early 2017 appear to have subsided, and marginal inflows have been experienced in spite of the increase in policy interest rates in the United States. Gross official reserves were estimated at $5.6 billion at end February 2017 compared to $6 billion at end 2016, while the Sri Lankan Rupee depreciated by 1.2% against the US Dollar during the year up to 22 March.

Shares edge up from 1-yr low on foreign buying

Reuters - Shares edged up on Friday from a more than one-year closing low as foreign investors picked up battered shares in a market that had already factored in a monetary policy tightening by the Central Bank, dealers said.

The Central Bank raised its benchmark interest rates by 25 basis points on Friday for the first time in eight months to contain high inflationary expectations and a possible acceleration of demand side inflationary pressures.

The Colombo Stock Index closed 0.3 percent up at 5,996.28, edging up from its lowest close since March 15, 2016 hit on Thursday. The index breached a key psychological barrier of 6,000 on Wednesday.

“Foreigners are buying in the ‘oversold’ market and are looking at the long term,” SC Securities Head of Research Yohan Samarakkody said.

“Rate hike was already factored in,” Samarakkody said, adding that some investors were expecting a larger hike.

Turnover stood at Rs. 1.92 billion ($12.7 million), more than double this year’s daily average of Rs. 671 million.

The index had lost 2.1 percent through Thursday since 7 March, when the IMF called for monetary policy tightening if credit growth or inflation do not abate.

The bourse rose to “neutral” territory from “oversold”, with the 14-day relative strength index at 30.480 points versus Thursday’s 24.614, Thomson Reuters data showed. A level between 30 and 70 indicates the market is neutral.

Foreign investors net-bought shares worth Rs. 551.1 million, raising the year-to-date net foreign inflow to Rs. 3.81 billion in equities.

Shares in Ceylon Tobacco Company PLC rose 3.9 percent, while Commercial leasing and Fiance PLC jumped 8 percent.

Rupee falls on raised key rates 

Reuters - The rupee closed lower on Friday on importer dollar demand, even as the country’s Central Bank raised benchmark interest rates by 25 basis points in a move also aimed at easing pressure on the currency.

The Central Bank raised interest rates for the first time in eight months, saying tighter policy was a precaution against a build-up of inflationary pressures.

The rate hike could help stabilise the rupee as rising imports and outflows due to rupee bond sales by foreign investors have exerted pressure on the currency, analysts said.

Rupee forwards were active, with two-week forwards closing at 152.60/70 per dollar, compared with Thursday’s close of 152.45/55.

“There was importer dollar demand. We have seen a state bank buying dollars, maybe to cover a large oil bill,” said a currency dealer, asking not to be named.

The Central Bank raised the spot rupee reference rate by 25 cents to 151.60 on Monday.

Foreign investors net-sold government securities worth Rs. 1.41 billion rupees ($9.3 million) in the week ended March 15, after two weeks of net inflows.

They have net-sold Rs. 63.3 billion of such instruments so far this year.