Wednesday Dec 11, 2024
Wednesday Dec 11, 2024
Saturday, 18 May 2013 01:16 - - {{hitsCtrl.values.hits}}
Standard Chartered Bank yesterday described the Central Bank’s policy rate cut last week as “aggressive” given some challenging issues within the economy but expects the monetary regulator to go into “pause” mode remainder of the year.
“The Central Bank of Sri Lanka (CBSL) lowered policy rates by 50bps – the repo rate to 7% and reverse repo rate to 9% – at its 10 May policy meeting, which was more than market consensus and our expectation of 25bps. It also increased commercial banks’ reserve maintenance period to two weeks from one week, with effect from 1 June 2013, to ‘offer greater flexibility’ in managing their liquidity. The statutory reserve ratio for lenders was maintained at 8%,” SCB Global Research said in its latest economic alert on Sri Lanka.
The CBSL’s post-meeting statement highlighted growth concerns amid moderating headline inflation as the key reason for its actions. Despite recent upward revisions in electricity tariffs, petrol and diesel prices, the CBSL expects CPI inflation to remain in single digits.
“We believe the CBSL will keep the repo rate at 7% until at least Q1-2014, in line with our original call for 50bps of rate cuts by year-end. However, we have lowered our 2013 GDP growth forecast to 6.5% from our earlier 6.7% projection due to the slower-than-expected export recovery in Q1-2013. The slow recovery in external demand poses downside risks to Sri Lanka’s exports (growth fell by 8.1% y/y in Q1-2013), which remain sluggish at present,” SCB said.
The bank said although the deeper-than-expected rate-cut is positive for T-bonds, supply concerns are likely to limit gains.
During January-April 2013, net Government borrowing (via T-bills and T-bonds) was equivalent to c.83% of the budgeted full-year amount, much higher than the 58% figure for the same period last year. “We expect T-bond yields to be range-bound, given supply concerns and stable policy rates. We forecast the 4Y T-bond yield to trade between 10.75% and 11.25% for the remainder of 2013 and we remain Neutral on T-bond duration,” SCB said.
Following are excerpts from the SCB report.
Was a 50bps rate cut too aggressive?
Further comments by the CBSL Governor indicate that a one-time 50bps cut (unlike our call for two 25bps rate cuts by year-end) will reduce uncertainty in the market and also expectations of further rate cuts in the near future, thus creating more stable conditions.
We believe the CBSL will keep the repo rate at 7.00% until at least Q1-2014, in line with our original call for 50bps of rate cuts by year-end. The IMF called for policy rates to remain on hold, as building economic stability on low inflation is paramount; it had previously cautioned the central bank, stating that inflation is not rising at an ‘unduly worrying rate’ and controlling the cost of living should remain the priority. In our view, this rate cut is aggressive but it sends a clear signal that growth concerns override inflation risks, while also reducing the likelihood of further rate cuts in 2013.
Inflation is still a risk
The expected moderation in headline inflation to 6.4% in Q2-2013 and 6.3% in Q3 is largely due to base effects and improvements in domestic supply, thus creating space for this 50bps rate cut to boost domestic demand. Although domestic and global supply conditions are likely to improve, inflation remains elevated and is still a risk owing to domestic factors (fiscal pressures); hence in our view that there is no room for further policy rate cuts. Since policy easing began in December 2012, when policy rates were cut by 25bps, credit growth has moderated further, to c.11% by March 2013, partly reflecting supportive base effects; it is currently much lower than the private-sector credit growth-rate target of 18.5% by year-end.
We expect inflation to spike in Q4-2013 due to a pick-up in domestic demand and private-sector investment resulting from current policy easing and lower interest rates. In addition, based on inflation trends over the past three years, inflation in Q4 tends to increase m/m (in November and December m/m inflation has risen by c.1%), indicating that seasonality plays a role.
The growth slowdown is a major concern
A key point in the central bank’s statement is that an aggressive 50bps cut was implemented to signal that the slowdown in growth is a major concern. It noted that it is “concerned by the slower-than-expected pick-up in economic activity” in Q1-2013 and attributed lower growth to a slowdown in net external demand, a consequence of the delayed global recovery. Higher tourism receipts and IT-related activity are likely to provide a cushion, but subdued factory output and lower external trade point to a growth slowdown. We have lowered our 2013 GDP growth forecast to 6.5% from our earlier 6.7% projection due to the slower-than-expected export recovery in Q1-2013. We expect Q1 growth (yet to be released) to fall short of our earlier 6.8% projection and now see it at 6.3%. CBSL highlighted that while it is concerned that growth in advanced economies is likely to remain in negative territory in 2013, growth in emerging market and developing economies remains on a robust trajectory.
Structural shortfalls in public finances persist
Although fiscal consolidation is underway, structural shortfalls in public finances persist. While recent electricity tariff hikes (along with lower global oil prices) are a step in the right direction, we believe significant revenue-generating reforms are needed to maintain fiscal stability. As a result – and as highlighted by the CBSL in its May policy statement – the financial position of loss-making State-Owned Enterprises (SOEs) is expected to improve, which should help reduce debt obligations to the banking sector, thus releasing greater resources for private-sector investment.
We have some concerns. In 2012 the seven largest SOEs reported total losses of Rs. 185 b, which has led to significant increases in their borrowing. This, along with elevated Government debt of 79.2% of GDP, leads to a crowding-out effect in the private sector. We feel the Central Bank’s 2013 GDP growth target of 7.5% is overly optimistic and hence tax-revenue growth could remain subdued. The Government’s 5.8% fiscal deficit target for 2013 is based on a 19.2% increase in revenue. In our view this will be difficult to achieve, since we expect GDP growth to touch 6.5%. The May policy statement highlights that the pick-up in domestic activity during the remainder of this year is expected to generate higher tax revenues; however, our lower growth forecast of 6.5% suggests that tax revenues are likely to fall short of the Government’s target.
Rates strategy
The T-bond market was pleasantly surprised by the CBSL’s unexpected 50bps cut in the policy rates at the 10 May monetary policy meeting; the 4Y T-bond yield moved c.30bps lower. Given our outlook of stable policy rates for the remainder of 2013, and supply concerns, we believe T-bond yields are likely to remain range-bound. We expect the 4Y T-bond yield to trade between 10.75% and 11.25% for the remainder of 2013 and we remain Neutral on T-bond duration.
The CBSL Governor stated that the higher-than-expected rate cut was to “reduce uncertainty in the market” about future cuts. This implies that the 50bps rate cut was a pre-emptive move by the CBSL, and signals a stable policy-rate environment for the remainder of 2013. Therefore we forecast no further change in policy rates until Q1-2014 and expect demand-supply dynamics to drive T-bond yields.
Year-to-date, T-bond issuance patterns indicate that the Government is front-loading its market borrowing. Indeed, during January-April 2013 net Government borrowing (via T-bills and T-bonds) accounted for c.83% of the budgeted full-year amount; this is much higher than the 58% figure for the same period last year. We believe subdued tax revenues amid slowing GDP growth might have led to increased reliance on market borrowing to fund the fiscal deficit. Expectations of fiscal slippage and additional market borrowing are likely to remain high, limiting further T-bond gains.
However, we do not expect a significant sell-off, as the yield curve is still steep and the long end is likely to be underpinned by the global environment, which is supportive of emerging markets bonds.
