As per the First Capital Research view, at the upcoming policy meeting, there is a strong case for maintaining policy rates in order to realize the impact of previous rate hikes amounting to a total of 850bps.
“As a result, we believe that there is a major probability of 60% to maintain rates at current levels. However, there is also a probability of 40% for tightening to compensate for higher inflation and to preserve the currency and foreign reserves thereby supporting macroeconomic stability. However, at the upcoming policy review we expect CBSL to maintain rates at current levels.” FC Research said in its Pre-Policy Analysis-May 2022.
The Monetary Board at the previous policy announcement held in April decided to increase policy interest rates; SDFR and the SLFR by 700bps to 13.50% and 14.50% respectively and this can be considered as the highest ever policy rate hike delivered in the history of Sri Lanka. On a cumulative basis, policy rates have increased by 850bps for this year at three policy announcements. Accordingly, considering the above factors we believe that CBSL might prefer to conserve its policy space and use it judiciously in the latter part of the year while also allowing the impact of previous rate hikes to materialize as it takes roughly a 3-6 months period to get reflected in the economy.
“Therefore, we believe that there is a lower probability for further rate hikes at the upcoming policy meeting.” Market interest rates are adjusting upwards gradually Market interest rates have been gradually adjusting upwards in response to tight monetary policy measures adopted thus far. Accordingly, in response to the 700 bps rate hike on April 8, AWCMR moved to 14.5% while AWPR was uplifted to 19.55%. Further, FD rates of major LCBs were seen shifting upwards in response to policy adjustments with FD ceiling on Market interest rates adjusting upward gradually with Non Bank Financial Institutions (NBFIs) increasing to 26.22% as of May 12-2022.
Moreover, in response to increased lending rates, credit disbursed for February-22 and January-22 declined to Rs 33.50 billion and Rs 36.10 billion respectively.
“Hence, we believe that further hike in policy rates would not be required at the upcoming policy review. Policy tightening may not curb cost-push inflation.”
Increase in global commodity prices has become a key determinant factor of the soaring inflation in Sri Lanka. In that, escalating crude oil prices due to supply-side constraints play a major role in the domestic context by inflating prices of the overall economy. Moreover, import restriction and Sri Lanka’s heavy dependency on imports are also promoting supply-side shocks, while also wearing out the competitiveness of certain local industries and thereby causing detriments to the consumers due to discretionary rise in prices of goods and services by suppliers.
“Therefore, monetary tightening may not address these issues arising via cost-push effects on inflation.”
As per 2021 article IV consultation report, IMF recommends having a substantial revenue based fiscal consolidation which includes reforms on strengthening VAT and income taxes, through rate increases and base broadening measures accompanied with energy pricing reforms to reduce fiscal risks from loss making public enterprises.