The country’s private sector and key markets begin a crucial week with the first monetary policy review under the new Central Bank Governor and mini-Budget of President Sirisena-Premier Wickremesinghe coming up.
The Monetary Board is scheduled to meet today or tomorrow for what would be its first meeting under the chairmanship of new Central Bank Governor Arjuna Mahendran, who received his letter of appointment from President Maithripala Sirisena on Friday. The customary post-monetary board meeting policy statement is expected to be released tomorrow.
The new Government’s mini-Budget covering four months of spending to April will be presented by Finance Minister Ravi Karunanayake on Thursday.
These upcoming events “may remove some of the uncertainties and may provide guidance especially in terms of the new administration’s policy framework,” stock broking firm Lanka Securities said adding the week “would be eventful.”
Standard Chartered Bank (SCB) last week in its first economic alert post-Presidential election, said the improved inflation trajectory could raise expectations of a policy rate cut at this week’s Monetary Board meeting.
“Our core view, however, remains that the Central Bank of Sri Lanka will keep policy rates on hold due to concerns about external stability,” SCB added.
It said a shift lower in yields in mid-2014 resulted in heavy FII outflows from the local Government Securities market, which have totalled a net $ 430 m since mid-July. This is equivalent to 12.4% of total foreign holdings of domestic government bonds. Since the presidential elections on 8 January, outflows have totalled $ 30 m. FII ownership now stands at 11.3% of the total outstanding bond market, below the 12.5% limit set by the Government.

SCB also said the Sri Lankan rupee (LKR) has come under pressure since September 2014, depreciating by 1.3% despite moral suasion by the CBSL aimed at keeping the exchange rate stable. Currency depreciation is particularly negative in Sri Lanka’s context given its high level of external debt. 44% of Government debt is held by foreigners.
“Given this and improving growth indicators – import and private credit growth are on the rebound we see no imminent pressure to lower policy rates,” SCB said.
However SCB said despite its core view of no policy rate change, it recognises that the new administration and CBSL Governor may have a different view on central bank policy.
“Given the President’s electoral manifesto, we cannot rule out further monetary easing, as the new administration may want to send out a series of positive announcements to revive domestic sentiment,” SCB said.
In the eventuality that the CBSL decides to ease monetary policy, SCB expects it to remove the 5% penalty interest rate charged on excess usage of the Standing Deposit Facility, and complement this with a 25-50bps policy rate cut.
“This would reduce the impact of banks parking excess liquidity in the Government Securities market, which would support yields. It would also be equivalent in a sense to marking monetary policy to market, as the call rate has traded below the Standing Deposit Facility rate (or repo rate) for some months now,” SCB said.
Given last week’s fuel price cuts, SCB said they are likely to lower the inflation trajectory further. “We forecast non-food CPI inflation at -1.7% m/m in February, which would take the y/y figure further into deflationary territory (it stood at -2.0% y/y in December 2014).
“We expect headline CPI to decline by 1% m/m in February, translating into a y/y reading of +1%. Headline CPI inflation is likely to average close to this level until October 2015, after which base effects will turn unfavourable. In the absence of further fuel price cuts, CPI inflation is likely to end the year in the 3.5-4.0% y/y range, comfortably within the CBSL’s target range of 2.0-4.0% for 2015. We lower our average annual CPI inflation forecasts to 1.8% for 2015 and 4.5% for 2016,” SCB added.
Wealth Trust Securities said the downward trend in secondary bond market yields continued for a second consecutive week with continued buying interest resulting in yields dipping further.
“This is all ahead of the vital monetary policy decision for the month of January, which is scheduled to be released on the 27,” it added. See full report on Page 7.
Rupee forwards ended a tad weaker on Friday on importer dollar demand, while the market waited for direction from an interim Budget on Thursday according to forex dealers.
Equity market saw greater volatility last week. Lanka Securities said policy uncertainties, impending change in SEC Chairman, potential probe on corruption and irregularities at CSE, EPF and looming signs of increasing interest rates are weighing on the investor sentiment and the equities lost 329 points on Friday or 4.3% post-election driving the year-to-date return to negative territory (-0.3%).
During the week the All Share index shed 237.23 points or 3.16% while S&P SL 20 index decreased by 169.14 index points or 3.98%. Subsequent to the index depreciation, the Market PE has declined to 14.2x from 14.8x.
Another concern is the net foreign outflow. For the week, foreign investors were net sellers with a net outflow of Rs. 304 million whilst the year-to-date foreign outflow rose to Rs. 779 million. Foreign investors in 2014 were net buyers to the tune of Rs. 22 billion.