December 2021

Inflation fears take over Omicron

Highlights

  • The stock of T-bills held by the CBSL was on the decline for most part of the month except on 29th December when it jumped by over LKR 200 Bn, likely the result of a provisional advance to the government.
  • The T-bill yields in both primary and secondary markets started to climb up. The belly of the yield curve shifted up while there was only a marginal shift in the shorter-end of the curve.
  • The yields of the SLISBs rose for the third consecutive month with notes with the nearest maturities posting largest gains.
  • Exponential recovery of tourist arrivals helped to generate around USD 120 Mn in receipts in December.
  • Worker remittances were around USD 325 Mn, an improvement over the previous month.
  • With the disbursement of the Yuan swap with China, the official reserves increased to USD 3.1 Bn.
  • The stock market remained subdued in December after experiencing a sharp gain in the month before.
  • Inflation rose to a new record level. Headline inflation increased to 12.1% while core inflation rose to 8.3% during the month of December (Y/Y).
  • The stock market remained subdued in December after experiencing a sharp gain in the month before.

Interest Rates

Short-term rates

Figure 1: Treasury bill yield and money market rates

Notes: AWCMR- Average Weighted Call Money Rate,
SDFR- Standing Deposit Facility Rate, SLFR- Standing
Lending Facility Rate, T-bill yields are for the secondary market, ARR – simple average of daily repo rates
Source: CBSL

The call and repo rates continued to hover marginally below the upper bound of the policy corridor in December. Overall daily volumes moderated during the month with the exception of 30th December where volumes spiked.

Overnight liquidity deficit grew surpassing LKR 300 Bn/day peaking to a new record low of 442 Bn towards the tail end of the month as heavy borrowing through Standing Lending Facility (SLF) continued. Open market operations were mostly used to drain liquidity but the CBSL injected about LKR 100 Bn through a single reverse repo during the third week. The stock of T-bills held by the CBSL was on the decline for most part of the month except on 29th December when it jumped by over LKR 200 Bn, likely the result of a provisional advance to the government.

The T-bill yields in both primary and secondary markets started to climb up. Performance of the primary auctions deteriorated over the course of the month. However, the volumes in the secondary market remained high.

Long-term rates

Figure 2: Yield curve of treasuries

Notes: Yields are based on the weekly average prevailed at the last week of the month, shorter end – less than 2Y, mid/intermediate tenor – 2 to 10Y, longer tenor – above 10Y, Source: CBSL

The belly of the yield curve shifted up while there was only a marginal shift in the shorter-end of the curve. The market absorbed LKR 120 Bn fresh bond issues amid healthy volumes in the secondary market.

Figure 3: AWPR[1] and 3M T-bill yield

Note: T-bill yield for secondary market, Source: CBSL

The private sector credit increased by LKR 60.5 Bn (M/M) in November, a faster rate than the two earlier months, as businesses were heading for the festive season. Overall growth in reserve money in December was small, hence credit may have expanded slower compared to November. AWPR rose by around 45 bps in December reflecting tight monetary conditions.

International rates

Figure 4: Month open international lending rates

Notes: The SOFR Averages are compounded averages of the SOFR over rolling 180-calendar day periods.

Source: New York Federal Reserve and global-rates.com

US treasury yields for short-term bonds declined sharply at the start of the month as a result of increasing Omicron infection rates. However, yields bounced back. Longer-dated maturities saw highest gains in months after year-on-year Inflation levels rose to a 40-year high of 6.8%. Yields continued to rise towards the middle of the month after the Fed announced the need for a faster tapering of bond purchases along with three potential interest rate hikes in 2022. Towards the end of the month yields rose again fueled by optimism over President Joe Biden’s COVID plan plus lower jobless claims.

USD linked Eurodollar rates, LIBOR USD and SOFR rates recorded yet another month of increase. 

The yields of the SLISBs rose for the third consecutive month with notes with the nearest maturities posting largest gains.

External Sector

Sri Lanka’s trade deficit remained flat in October compared to the month before on Y/Y basis. Merchandise exports increased by 55.1% (Y/Y) to USD 1.2 Bn.

Exponential recovery of tourist arrivals helped to generate around USD 120 Mn in receipts in December. Worker remittances were around USD 325 Mn, an improvement over the previous month.

Figure 5: Gross official reserves (Mn USD)

Source: CBSL

The CBSL has sold close to USD 425 Mn of gross official reserves to maintain the current peg on rupee during the last month of the year. Around USD 171 Mn forex payments were pending for December. In this setting, with the disbursement of the Yuan swap with China, the official reserves increased to USD 3.1 Bn.

Figure 6: Interbank forex market daily avg. volumes (USD Mn)

Source: CBSL

The interbank spot and forwards volumes declined in December. Outstanding forward volumes reverted after growing in the previous month.

Prices & Wages

Figure 7: CCPI and Nominal Wage Rate Index of the informal private sector (Y/Y)

Notes: WRI (100=2012), CCPI (100=2013)

Sources: CBSL, CSD

Private Wage growth continued to recover and posted 16.5% growth (Y/Y) in November on the back of improving economic activity along with increasing recruitments by businesses to meet the demand during festive season.

Inflation rose to a new record level. Headline inflation increased to 12.1% while core inflation rose to 8.3% during the month of December (Y/Y). Food inflation rose to 22.1% from 17.5% mainly due to increases in prices of vegetables, rice and meats. Non-food inflation increased to 7.5% from 6.4% resulting from increased prices of housing, transport and health.  

Equities

Domestic Market

Figure 8: ASPI (M/M)

Source: CSE

The stock market remained subdued in December after experiencing a sharp gain in the month before. The ASPI and S&P recorded 6.9% and 9.2% gains respectively. The index performance continued to be driven by a few selected shares. The detection of the Omicron variant within the country along with power outages caused the bourse to dip towards the end of the month. Transport and Energy were the top performers. Overall PBV (Price-to-Book-Value) increased from 1.60 to 1.67 favouring sellers.

Figure 9: GICS sector performance- December

SectorIndex Points Gained
Transportation15587
Energy795
Household & Personal Products324
Insurance296
Capital Goods214
Automobiles & Components189
Health Care Equipment & Services119
Retailing118
Food, Beverage & Tobacco95
Materials85
Consumer Durables & Apparel59
Real Estate44
Consumer Services39
Food & Staples Retailing29
Commercial & Professional Services10
Telecommunication Services5
Utilities4
Banks-23
Diversified Financials-358
Global Markets

US stocks rallied in December as early data suggested that the health impacts of the Omicron variant would be less severe than initially feared. Dow Jones (+5.4%), S&P500 (+4.4%) and Nasdaq (+0.7%) recorded solid gains. Equities in Consumer Services, Health Care, Consumer Staples and Real Estate experienced the largest gains. European markets rebounded sharply from November losses with France, Germany and the UK being top gainers. Asian stocks were also mostly buoyant despite Chinese markets plummeting due to isolated lockdowns and potential defaults in some of the larger real estate companies.

Commodities

Figure 10: Crude oil price

Source: Bloomberg quoted in CBSL

Global oil prices dropped earlier December over Omicron fears. However, prices stabilized later after studies showed that the new strain was less severe than initially feared. Oil received a boost as the Fed announced in its latest policy review meeting that it would increase tapering of its bond buying programme in order to combat rising inflation.

Figure 11: Tea (All Elevations) price and quantity sold at weekly auctions

Source: Forbes & Walker

Tea prices at the Colombo auction declined marginally after rising sharply in the previous month resulting from improved supply at the start of the month. Supply however declined due to poor weather conditions in later weeks despite demand remaining strong in international auctions.

Read ICRA Lanka’s report, Sri Lanka plantations at a fork in the road, thrive or survive?

Figure 12: Rubber price weekly auctions

Note: Price of Latex 4X

Source: RRISL

Global rubber price declined further as a result of rising Omicron variant throughout the world. Furthermore, new lockdown procedures implemented in China are likely to curb industrial activity which in turn could reduce global demand.

Figure 13: Coconut price weekly auctions

Source: CDA

Coconut supply declined towards the end of the month mainly due to adverse weather conditions causing auction prices to rise.

Figure 14: Metal price index (2016=100)

Notes: Base metals index includes Aluminum, Cobalt, Copper, Iron Ore, Molybdenum, Nickel, Tin, Uranium, and Zinc, precious metals index includes Gold, Silver, Palladium, and Platinum

Source: IMF

Gold prices rose during the month as the dollar weakened after the Federal Reserve decided to further cut back on its bond buying programme. Price hikes were also supplemented as gold acts as a natural hedge against rising inflation in the US. Prices edged up higher towards the end of the month following lingering fears that the Omicron variant could throw a wrench in the global economic recovery.

Base metal prices showed mixed signals during the month as some metal prices declined due to economic slowdown from rising Omicron variants. Furthermore, China implemented lockdowns which curbed demand for industrial metals. However, demand for key base metals such as iron ore and Copper increased during the month as industrial activity is expected to pick up next year.

Read ICRA Lanka’s report on the implications of rising commodity prices for Sri Lanka.

Real Sector

Figure 15: PMI deviation from point of neutrality (Index points)

Notes- negative values indicate the sector is generally contracting on a month-on-month basis while positive values indicate the sector is expanding. The strength of contraction or expansion is manifested by the magnitude of the figure. Source: CBSL

The PMI index for both services and manufacturing sectors grew in November with continuing economic recovery.  Employment in the manufacturing sector continued to expand. Supply lags were persistent. Both sectors experienced new businesses.

Read ICRA Lanka’s take on what lies beyond the pandemic for Sri Lanka

Outlook for January – February

Sri Lanka has shown resilience against Omicron so far with minimal interruption to economic activities at large. This is a critical factor to ensure better economic performance this year.

The GoSL continues to rely on short-term financing such as swaps to address external sector imbalances. Some government-to-government arrangements are also under discussion, which may help to ease the balance of payment pressure to some extent in the short term, once realized. The timing of such arrangements is unclear at the moment. However, the challenge facing the country still remains acute.

Inflation is currently fueling some second-round effects. The GoSL in January announced LKR 229 Bn economic relief package which includes special allowance for selected vulnerable groups. This will further feed into the current inflationary spiral, given the shortages of essentials, as imports continue to be impaired by the current forex crisis.

Current bull-run on oil may further aggravate the pressure on the balance of payment and the state-run utilities will be in a tough position to hold tariffs with weaker balance sheets of said institutions. Tourist arrivals are encouraging and will help improve the current account balance.

Financial institutions may continue to factor inflation into pricing which will lead to further increase in retail lending rates. Sluggish global and domestic economic conditions together with tighter monetary policy may result in weaker credit demand in the first quarter of 2022. 

Rating Actions

Following rating actions were taken by ICRA Lanka during the month of December

Visit https://www.icralanka.com/ratings/ to read the rating rationales.

IssuerIssueActionPrevious RatingCurrent Rating
First Capital Holdings PLCIssuer RatingReaffirmed[SL]A (Stable)[SL]A (Stable)
First Capital Holdings PLCSenior Unsecured Redeemable Debenture Program (LKR 2000 Mn)Reaffirmed[SL]A (Stable)[SL]A (Stable)
First Capital Holdings PlCCommercial Paper program (LKR 1500 Mn)Reaffirmed[SL]A1[SL] A1
First Capital TreasuriesIssuer RatingReaffirmed[SL]A (Stable)[SL]A (Stable)
First Capital TreasuriesSenior Unsecured Redeemable Debenture Program (LKR 750 Mn)Reaffirmed[SL]A- (Stable)[SL]A- (Stable)
Bank of CeylonBasel III compliant, Tier 2 subordinated Debenture Program (LKR 5400 Mn)AssignedN/A[SL]AA+ (Negative)
Multi Finance PLCIssuer RatingReaffirmed[SL]C+ (Negative)[SL]C+ (Negative)
Alliance Finance Company PLCIssuer RatingReaffirmed[SL]BBB- (Negative)[SL]BBB- (Negative)
Alliance Finance Company PLCProposed Secured Asset Backed Trust Certificates (LKR 1000 Mn)AssignedN/A[SL]BBB (Negative)
Regional Development BankIssuer RatingRevised[SL]A- (Negative)[SL]BBB+ (Negative)
Regional Development BankSubordinated Unsecured Redeemable Debenture Program (LKR 2000 Mn)Revised[SL]BBB+ (Negative)[SL]BBB (Negative)
MCB Bank LimitedIssuer RatingReaffirmed[SL]A+ (Stable)[SL]A+ (Stable)
Prime Finance PLCIssuer RatingRevised[SL]BBB-[SL]BBB- (On Watch)
Commercial Leasing and Finance PLCSecured Asset Backed Trust Certificates (LKR 3000 Mn)AssignedN/A[SL]A+ (Stable)

[1] AWPR is calculated based on the submissions made by the commercial banks to the CBSL on the rates offered to customers who borrowed more than LKR 10 Mn for less than three months.


Disclaimer

This publication has been prepared by ICRA Lanka solely for information purposes without regard to any particular user's investment objectives, financial situation, or means. The information in the publication is not an investment recommendation and it is not investment, legal or tax advice or an offer or solicitation to purchase or sell any financial instrument. Reasonable care has been taken to ensure that this publication is not untrue or misleading when published, but ICRA Lanka does not represent that it is accurate or complete. ICRA Lanka does not accept any liability for any direct, indirect or consequential loss arising from any use of this publication.