Sri Lanka stocks fall despite rate cut; rupee steady

Reuters: ** Sri Lankan shares ended weaker on Friday, snapping three straight sessions of gains, as foreign investors sold risky assets and the market shrugged off a widely expected rate cut by the central bank. 

** The rupee closed steady, market sources said. 

** Before the markets opened on Friday, the central bank cut its key interest rates to support its faltering economy as overall business and consumer confidence slumped in the wake of last month’s deadly bomb attacks. 

** Traders said the Easter day bombings and aftermath violence, and worries over slowing economic growth weighed on investor sentiment. Most investors have shied away from the market since the April 21 bombings that killed more than 250 people. 

** Sri Lanka is unlikely to hit its full-year economic growth target of 3-4% following the Easter Sunday bombings, junior finance minister Eran Wickremeratne told Reuters last week. A Reuters poll has predicted the growth to slump to its lowest in nearly two decades this year. 

** The central bank chief said on Friday that he expected the economy to grow by 3% or less this year due to the impact of the deadly Easter bomb attacks, and the bank was preparing a downward revision to its earlier projection for 4% growth.

** The benchmark stock index ended 0.26% weaker on Friday at 5,310.95. It rose 0.3% for the week, recording its second straight weekly gain. The bourse has declined 12.25% so far this year. 

** The government’s pension fund has resumed investing in risky assets as the stock market is “extremely undervalued at the moment and is considered a good time to go into”, the central bank governor said. 

** Turnover was 167.8 million rupees ($952,327), less than a third of this year’s daily average of around 550.6 million rupees. Last year’s daily average was 834 million rupees. 

** Foreign investors sold a net 11.4 million rupees worth of shares on Friday, extending the year-to-date net foreign outflow to 5.55 billion rupees worth of equities. 

** The rupee ended steady at 176.40/55 per dollar, compared with Thursday’s close of 176.40/50, market sources said. 

** Analysts expect the rupee to weaken further as money flows out of stocks and government securities. 

** The rupee fell 0.06% for the week but is up 3.5% for the year. Exporters had converted dollars as investor confidence stabilised after a $1 billion sovereign bond was repaid in mid-January. 

** The rupee dropped 16% in 2018 and was one of the worst-performing currencies in Asia. 

** Foreign investors bought a net 2.1 billion rupees worth of government securities in the week ended May 22, but the island nation saw a net foreign outflow of 19.1 billion rupees so far this year, central bank data showed. 

** Investor sentiment was damaged at the end of last year when President Maithripala Sirisena abruptly removed Prime Minister Ranil Wickremesinghe and then dissolved parliament. A court later ruled the move unconstitutional, but the political turmoil led to credit rating downgrades and an outflow of foreign funds. 

($1 = 176.2000 Sri Lankan rupees) 

(Reporting by Ranga Sirilal and Shihar Aneez; Editing by Subhranshu Sahu)

Monetary Policy Review: No. 3 – 2019 The Central Bank of Sri Lanka Reduces its Policy Interest

Rates The Monetary Board of the Central Bank of Sri Lanka, at its meeting held on 30 May 2019, decided to reduce the Standing Deposit Facility Rate (SDFR) and the Standing Lending Facility Rate (SLFR) of the Central Bank by 50 basis points to 7.50 per cent and 8.50 per cent, respectively. The Board arrived at this decision following a careful analysis of current and expected developments in the domestic economy and the financial market as well as the global economy, with the broad aim of stabilising inflation at mid-single digit levels in the medium term to enable the economy to reach its potential.

A dovish approach to monetary policy is observed globally 

Driven by a number of factors such as increased trade tensions, weakened business confidence and softened external demand, a slowdown in global economic growth is observed. This has prompted key advanced economies to become increasingly dovish, while several emerging market economies have also relaxed their monetary policy stance to support economic activity, given subdued inflation pressures. Meanwhile, despite the slowdown in global growth, international crude oil prices have remained elevated due to geopolitical uncertainties. 

Subpar economic growth is likely to be further affected by the Easter Sunday attacks

Following the modest growth in 2018, the economy is expected to have grown at a higher pace during the first quarter of 2019, mainly due to improved performance in Agriculture and Industry-related activities. However, the Easter Sunday attacks have affected confidence and sentiments of economic agents, particularly disrupting tourism and related activities. Although normalcy is gradually returning to economic activity, a lower than initially projected growth could be anticipated during 2019. 

Market lending rates remained downward rigid, despite the measures already taken 

Sizable liquidity injections through the reductions in the Statutory Reserve Ratio (SRR) along with appropriate and prudent open market operations (OMOs) have resulted in a reduction in the Average Weighted Call Money Rate (AWCMR) by around 50 basis points so far in 2019. Yields on Government securities have also adjusted downward sharply during the year. In the meantime, considering the high nominal and real interest rates on deposit and lending products, the Central Bank imposed maximum interest rates on deposit products in April 2019, thus reducing the cost of funds of financial institutions, enabling them to reduce lending rates and enhance credit flows to the real economy. 

In spite of liquidity injections, decline in AWCMR and yields on Government securities, as well as the recently introduced maximum interest rates on deposit products, market lending rates have failed to show any sign of commensurate downward adjustment.

Amidst elevated market lending rates, private sector credit contracted notably
Following a higher than projected credit expansion, particularly in the latter part of 2018, credit extended to the private sector by commercial banks contracted, in absolute terms on a cumulative basis, during the first four months of 2019. High market lending rates, sluggish growth in economic activity, subdued business confidence, as well as the settlement of arrears by the government on account of various projects which enabled repayments to the banking sector, were amongst the factors which contributed to this contraction. Driven by the slowdown in private sector credit, the year-on-year growth of broad money (M2b) also decelerated so far in 2019. 

Improvements in external sector conditions are observed, particularly in relation to the trade balance 

The trade deficit narrowed with increased performance in export earnings, while import expenditure declined sharply during the first three months of 2019 mainly in response to the flexible exchange rate policy maintained by the Central Bank ahead of adopting the proposed flexible inflation targeting monetary policy framework. The improvement in the trade deficit is likely to negate the adverse impact on the current account arising from the slowdown in services exports caused by the contraction in tourism in 2019. Nevertheless, it is expected that earnings from tourism would rebound with the support of improved security conditions and the relaxation of travel advisories by several key countries of origin of tourists, along with recently introduced policy measures and promotional campaigns to revive the sector. Meanwhile, the receipt of the sixth tranche under the Extended Fund Facility programme with the International Monetary Fund (IMF-EFF) in May 2019 is expected to boost investor sentiments. With these developments, the Sri Lankan rupee has recorded a cumulative appreciation of 3.7 per cent against the US dollar so far during the year. Gross official reserves are estimated at US dollars 7.2 billion at end April 2019, providing an import cover of 4.1 months. 

Despite transitory upticks, a threat to the inflation outlook is not anticipated for the medium term 

Headline inflation and core inflation, as measured by the year-on-year change in both Colombo Consumer Price Index (CCPI) and National Consumer Price Index (NCPI), showed some acceleration during the year, partly due to the lagged effect of the sharp depreciation of the rupee during 2018. With subdued aggregate demand and well anchored inflation expectations, the recent acceleration in inflation is projected to be short-lived. Accordingly, inflation is likely to remain in the desired 4-6 per cent range in 2019 and beyond, supported by appropriate policy measures. 

The monetary policy decision is expected to induce a reduction in market lending rates 

At the last review of the monetary policy stance, the Central Bank provided forward guidance of a possible policy relaxation, if the current trends in the global financial markets, trade balance, and credit growth continue. These trends have continued, and in addition, the economy has been affected by the Easter Sunday attacks and its adverse spillover effects on related sectors. Accordingly, the Monetary Board was of the view that a relaxation of the monetary policy stance is appropriate, and decided to reduce the Standing Deposit Facility Rate (SDFR) and the Standing Lending Facility Rate (SLFR) of the Central Bank by 50 basis points to 7.50 per cent and 8.50 per cent, respectively. Along with the developments in the domestic financial markets so far during the year, the monetary policy decision to reduce policy interest rates is expected to induce a swift and sizable reduction in market lending rates. 

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