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Policy rates to hold steady amidst sweeping measures to insulate economy: First Capital

First Capital Research believes that the Central Bank of Sri Lanka (CBSL) will maintain same policy stance in this monetary policy review, but given the concerns around economic growth,  the research arm stated that there is a probability although to a lesser extent that CBSL is likely to further ease its policy rates.

" The CBSL either can choose to hold policy rates steady or cut by a 25bps or 50bps while, hike is off the table due to the lackluster economic growth. We believe that there is a 60% probability to hold rates due to the considerable improvement in high frequency indicators and with fiscal and monetary measures implemented so far. However, there is a 20% probability each for 25bps and 50bps rate cut to support economic growth," First Capital Research said in its latest report.

At the previous policy meeting held on 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.

The next CBSL’s monetary policy review is scheduled to be announced on 19th January 2021 at 07.30 am.

Key Arguments by CBSL for maintaining its policy stance on 26 November 2020 as follows:

The second wave of COVID-19 has destabilised global growth prospects, while all central banks across the globe adopted an accommodative stance. However, vaccine expectations have helped improve sentiment.
The impact of the second wave is not expected to be as distructive as in the first wave, as mobility restrictions were imposed only in selected areas. Measures already in place is expected to enable to rebound the economy in 2021.
External sector remains resilient amidst challenging global developments.
The expansion in money and credit supply continued.
The research arm further stated that excess liquidity prevailing in the domestic market requires no change in current policy stance.

“As a response to the measures taken by the Government, market liquidity increased to an elevated level while recording a three-year high on 1 January 2021 amounting to Rs. 266.5 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 of further policy easing at the upcoming review,” it said. 

It further stated that the gradual rebound in private credit to power economic growth.

"Private sector credit increased by LKR 41.0Bn in Nov 2020 recording a growth for the fourth consecutive month indicating a revival in gross loan disbursements up to pre-pandemic levels in Dec 2019. The continuous uptrend in private sector credit till Nov 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 4Q2020 and onwards,"