October 2019

Overview

With the lending cap, the long-term interest rates have declined. In this environment, the demand for credit from the private sector increased while the liquidity in the banking sector recovered. But the banks seemed to prefer granting loans selectively to reduce the risk level in a surging NPA climate. The yield curve indicated investors’ expectation about economic recovery in the medium to long run. Gross Official Reserves shed close to US$ 900mn in September, while the rupee continued to depreciate in October. Inflation edged up to 5.4% due to increase in prices of non-food category. The private sector wages experienced negative growth for the second month from June. Stock market performance was characterized by net domestic buyers and ASPI experienced over 4% growth during the month of October. Recovery of the real economy was evident by improvements in Purchasing Managers’ Index in both the manufacturing and services sectors. Tourism sector is still weak but the tourist arrival numbers show signs of recovery post Easter Attacks.

Interest Rates

Short-term rates

Call rates saw a marginal increase with the demand for credit from private sector increased by about LKR 54Bn in September. In the meanwhile, T-bill rates remained flat while the credit to government contracted by LKR 29Bn. In October, AWCMR has increased, probably due to increased demand for credit from the private sector.

Long-term rates

Interest rates in the international markets increased marginally in October. Fed rate cut is likely to have a downward pressure on LIBOR in November. AWPR continued to decline in October by about 20 basis points. The rate has been declining since February this year contrary to AWLR which started declining significantly only after May, following intense pressure by the CBSL on banks to cut lending rates. Moody’s and Fitch warned against the lending cap earlier. Large international banks are the main contributors for declining interest rates as some are offering lending rates as low as 8.51% for their key customers. Lower interest rates will benefit the corporate sector with lower financial costs, thereby boosting profitability.

The yield curve has got steeper indicating investors’ expectation about economic recovery in the medium to long run. The bond yields for some mid (6 to 12 Yrs) and short tenor (<2Yrs) government securities have dropped. With the private sector credit expansion in November the banks’ risk appetite has improved. Therefore, the banks may be compelled to lend for longer duration.

External Sector

Apparel exports have fallen in September by 14%. In October the rupee experienced a marginal depreciation against US$. CBSL held the policy rate to counter currency instability. Forecast based on forward rates available in October show the rupee to further depreciate by about 1% by December. However, with the latest developments post Presidential Election the forecasts may vary.

Demand for US$ will surge in coming few months as imports pick up during the festive season putting further downward pressure on the rupee. Reserves shed close to US$ 900mn in September amidst weakened export earnings.

Prices & Wages

Inflation rose to 5.4% in October. The increase in inflation is mainly driven by the increase in prices of non-food category. Rising price levels was another reason for CBSL to hold policy rates. Real wages recorded slower growth in August and is expected to grow faster in September and October with surging demand for labor. Sri Lanka saw unemployment raising to 4.9% in 2019 Q2, highest since 2015 Q3.

Stock Market

ASPI showed consistent and gradual gain in ASPI over the month of October, following the meagre performance in September. IT, telecom, construction, and manufacturing stocks performed well during the month. Domestic participation improved while foreign investors exited the market.

Real Sector

IMF cut Sri Lanka’s economic growth for 2019 to 2.7%. However, manufacturing and services activities improved in October. Improvement in manufacturing is mainly due to an increase in production and new orders in manufacturing of food and beverages sector to meet the upcoming festive season demand. Employment also increased in the manufacturing of food & beverages and wearing apparel sectors. This was mainly due to the recruitment of new employees to increase the production levels to meet the higher demand in the period ahead. Improvement in services is mainly due to increase in new businesses in Financial and Insurance sectors. Advertising campaigns ahead of the presidential election and increased promotional activities of banks have contributed to the increase in business activities. Tourist arrivals are still under the last year’s levels but the signs of recovery are evident with increasing occupancy levels.

Banking Sector

Liquidity levels in banking sector saw further recovery in August. As the liquidity level improved banks maintained their investments in government securities and started expanding the loan portfolios.

Outlook for November

Stock market is likely to sustain the momentum in the near term boosted by the investor confidence following the recent presidential election. Long term interest rates are likely to experience further decline. Private sector credit is likely to surge ahead of the festive season. Imports will pick up creating pressure on the rupee. Real sector performance is also expected to improve in preparation for the December season in the retail and tourism sectors.


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