February 2020

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January: Private credit was weak while government credit (grew by LKR120 Bn Y-o-Y) recorded a strong growth. Wage growth further slowed at a subpar rate to inflation. Manufacturing (7 points above threshold) and services sectors (3 points above threshold) grew at a slower phase.

February: Inflation climbed to 6.2% which is above the CBSL target inflation range of 4 to 6%. Lending rates continued to decline in line with the accommodative monetary policy stance; prime lending rates reduced towards upper single digit levels (9.47%), while the AWCMR hovered around 7%. A large liquidity build-up was observed towards the last week. The debt market was relatively active; however, foreigners were exiting the market in the face of growing global economic uncertainty (LKR 17 Bn net outflows). The shorter end of the yield curve moved up by about 20 basis points, while the rest saw the yields lifted up by as much as 60 to 65 basis points for most tenors. Rupee continued to depreciate for the most part of the month but moderated in the last week. The reserve position improved to USD 7.9 Bn possibly due to the proceeds from the Sri Lanka Development Bond (SLDB) issue. Corona virus fears upset the Asian equities with the ASPI continued its downward momentum (-6% MoM). The total net foreign outflow from the Colombo Stock Exchange (CSE) was LKR 1 Bn during the month. The virus outbreak caused the tourist arrivals to drop by 18% Y-o-Y pushing the industry recovery further out.

Interest Rates

Credit demand

In January, net credit demand from the private sector grew only by LKR 200 Mn while government credit spiked by LKR 120 Bn M-o-M basis. It is doubtful if the CBSL rate cut could help to recover the private credit demand in February, as the global slowdown has had ripple effects on the local economy. Many Central Banks in the world were seen cutting key rates to combat the economic shocks coming from corona virus.

Figure 1: Credit to government and private sector (M-o-M) LKR bn

Source: CBSL
Short-term rates

The call rate volatility was somewhat subdued in February compared to the month before and was in the range of 6.95 -7.00%. In the last week of February, there was a massive liquidity build-up of over LKR 66 Bn, the highest so far for the year. The liquidity spike was a result of the transfer of the CBSL profits. Due to this, call rates slumped which caused the call volumes to quell. Repo rates were steady until the liquidity build-up drove it down. The CBSL mopped up LKR 75 Bn using repos in the last 3 business days of the month, which caused the overall liquidity to go down somewhere close to LKR 44 Bn.

There were no bond auctions in February and the primary market for T-bills remained relatively active with subscriptions exceeding two times the amounts offered in all weeks during the month. Following the policy rate cut, T-bill yields in the primary market dropped momentarily, but continued to edge up and saw 5 to 15 basis point increases in yields in the subsequent weeks of the month. 

Figure 2: Treasury bill yield and call money rate

Notes: AWCMR- Average Weighted Call Money Rate,
SDFR- Standing Deposit Facility Rate,
SLFR- Standing Lending Facility Rate
Source: CBSL, February figures are ICRA Research
estimates based on weekly/daily CBSL data
Long-term rates

LIBOR (USD 1 Y) rate fell during February amidst the weakening of global economy and loosening of key rates by many Central Banks.

AWPR fell over 20 basis points to 9.47% following the policy rate cut while ‘stickier’ AWLR was expected to decline at a much lower pace.

Figure 3: Local and international lending rates

Notes: AWPR- Average Weighted Prime Lending Rate, AWLR, Average Weighted Lending Rate
Source: CBSL and global-rates.com

Secondary bond market remained active in February characterized by significant reduction in foreign ownership of government securities. On a net basis, the foreign ownership of government securities declined by about LKR 17 Bn. The policy rate cut triggered foreign investors to exit from the market. In addition, during the last week of the February, investors sought refuge in safe –haven assets such as US Treasuries, which moved capital out from domestic bonds. US Treasury yields dropped markedly, even as the demand shot up.

Figure 4: Yield curve of government securities

Source: First Capital Research, CBSL

Immediately after the CBSL rate cut, the yield rates for government securities dropped drastically but in the subsequent weeks, they have started to edge up across the board. Shorter end of the yield curve moved up by about 20 basis points, while the rest saw the yields lifted up by as much as 60 to 65 basis points for most tenors.

External Sector

Rupee depreciation continued in February and it was especially acute for the week ended on 21st where it dropped marginally south of LKR 182/USD but appreciated slightly in the last week of February. Further depreciation is likely in the month ahead as forecasted by the forward rates.

Outstanding forward volume also experienced a decline, a likely result of an expected decline in exports/imports emanating from coronavirus disruptions.

Figure 5: Exchange rate (US$/LKR)

Note: Forecast is based on the forward rates prevailed during the end month.
Source: CBSL

The reserve position improved to USD 7.9 Bn possibly due to the proceeds from the Sri Lanka Development Bond (SLDB) issue held in January amounting to USD 100 Mn. Previously ICRA Lanka warned that the offer document of the floating rate SLDBs are ill suited to handle the LIBOR phase out in 2021 (click here to read the original article).

Figure 6: Gross official reserves (Mn US$)

Source: CBSL

Prices & Wages

Slowdown in wages (WRI 2.1%) is especially problematic as it indicates eroding purchasing power. Wages grew more than the inflation for the first 8 months of 2019. Slowdown in January this year could be attributed to the corona disruptions.

Inflation hit 6.2%, which is outside the CBSLs target band of 4 to 6%, in February mainly due to an increase in prices of food items caused by disruptions to vegetable supply. In addition, there was an increase in prices of non-food categories as well.

The CBSL implicated that it is expecting the inflation to decline in March, but with sudden surge in demand for food supplies driven by Corona fears, we expect the inflation to remain relatively high for March as well.

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

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

Stock Market

Global stock markets suffered heavily as a result of the negative sentiment coming from the Corona virus scare.

ASPI lost 5.78% on M-o-M basis. Foreigners were the net sellers for seven consecutive months and sold over LKR 1Bn on a net basis in February. Almost all sectors in the ASPI lost value in February. Noteworthy deterioration in value was observed in Transportation (-185 index points), Consumer durables & apparels (-120 index points), Diversified financials (-104 points), and Automobiles & components (- 86 index points) sector shares.

Figure 8: ASPI (M-o-M)

Source: CSE

Figure 9: Net foreign purchases of equity (Mn LKR)

Source: CSE

Real Sector

Manufacturing sector continued its slow expansion in January mainly due to the slowdown in new orders and stock of purchases. Due to the COVID-19 virus outbreak in China, local manufacturers experienced a significant delay in supplies. Further, a slowdown in stock of purchases in textile & wearing apparel sector could be observed due to Chinese New Year holidays.

Services sector also recorded a meagre expansion in January supported by the expansion in new businesses, business activity, employment and expectations for activity.

Tourist arrivals declined by about 18% in February on Y-o-Y basis pushing the full recovery of the industry further out. Corona virus worries was the main contributor to this poor performance as witnessed by a slump in Chinese (-55.1%), US (-11.6%) and European (-7.8%) tourists.

Figure 10: PMI deviation from point of neutrality (Index points)

Notes- negative values indicate 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

Figure 11: Monthly tourist arrivals (Y-o-Y)

Source: SLTDA

Outlook for March

Weaker credit demand from the private sector is likely to persist, while the activities in the real economy may remain stagnant. In this backdrop wage growth is less likely to recover. COVID-19 fears are expected to continue to cripple the tourism sector in the near term. Both short and long-term interest rates likely to show downward adjustment. Activity in debt and equity markets is expected to be volatile and foreign participation may not improve. Further depreciation of rupee is likely as forecasted by the forward rates. Inflation is likely to edge up as a supply disruption may force prices to go up.

Rating Actions

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

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Published date: 3/13/2020

Document #: meufeb


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